Mr. PoP and I have generally taken a pretty “hands-off” approach to our 401Ks over the past few years. Although we work for different companies, both of our employers use Fidelity Net Benefits to manage our 401Ks, and we have greatly relied on one aspect of it – the automated annual contribution increase.
Basically it’s a setting in our accounts that automatically increases the employee contribution percentage on your 401K each year by an amount you specify. For example, when I started with my employer, I set a 12% contribution, set to increase by 2% each calendar year. So in 2011 it changed to 14%, and then in 2012 to 16%. Mr PoP’s current settings are at 16% of his pay, with a 2% yearly bump as well.
The main benefit of the automatic increase is that as we earn cost of living (COL) raises, the bump ensures that most of that COL raise goes directly to the retirement accounts. We try to keep living on the same dollar amount, regardless of inflation. Great, right?
So what’s the drawback?
We recently realized that this automated bump has put us a little too much on auto-pilot when it comes to these accounts and we were overdue for another look at them. So we’re going to be going through these over the next few months to see what we can do to maximize these retirement accounts.
In case you’re new to the concept of a 401K account, it’s basically a retirement account in the employees name, usually in lieu of a pension. Many employers offer matching funds as an incentive to get you to use the 401K, and those matching funds are usually expressed as percentage match. Mr PoP’s match is pretty typical for his industry:
- a 50% match up to 6% of his salary, so it has a maximum match of 3% (half of 6%)
So if he puts 6% of his salary into his 401K, they match half of that (up to an additional 3%) so 9% would go in. Since Mr PoP is currently putting 16% of his salary into his 401K, with the match, he is actually getting 19% (16% + 3% since he’s maxing out his match by putting in at least 6%) deposited into his account each pay period.
When I set my 401K up, my match was:
- a 25% match up to 12% of my salary – so a maximum match of 3% (one quarter of 12%)
You can see why I started my 401K at 12%. I wanted to make sure I was getting all the eligible matching funds! But, since we’re both at 16% employee contributions right now, I thought I should have been getting the same 19% deposited into my account as Mr. PoP. However, when I looked at the details of my Fidelity deposits recently, I realized I was wrong.
I, Literally, Missed The Memo
When I wasn’t paying attention, our company changed the 401K matching contributions policy and I filed the email announcement from HR without reading it. Oops! Luckily it was a change for the better, and it was pretty subtle. Now my match is:
- a 25% match without a cap*
So my 16% employee contribution is getting a match equal to one fourth of that amount, or 4%. So my total contribution each pay period is 20%, not the 19% I thought it was!
I don’t feel too bad for missing a 1% difference in matching funds. That’s about $750/year spread over 24 deposits that are going into an account where the balance is constantly fluctuating with the market. I’m not going to beat myself up over missing this for the past couple years, but since I’m now aware of it, I wondered what we should be doing to maximize our matches.
Looking at our Separate 401K Accounts Together
|Mrs PoP||Mr PoP|
|Employee Contribution||16% = $12K||16% = $12.8K|
|Employer Contribution||25% uncapped = $3K||50% capped @3% = $2.4K|
Our combined employee + employer contributions has been ~$30.2K each year.
Goal – Keep Take Home Pay the Same, but Maximize Employer Matches
Since we’re busy paying down lots of debt, we want to keep our take-home pay the same for now. But we want to max out our employer matches within this restriction. How do we do that?
(1) Max out Mrs. PoP’s contribution up to the current federal limit of $17K/yr. This changes Mrs. PoP’s employee contribution to 25%*$17K = $4.25K
(2) Decrease Mr. PoP’s contribution so our overall employee contribution stays the same at about $25K. To figure out Mr. PoP’s employee contribution, we just subtract the $17K going to my account from the $25K we want to contribute as a team. $25K-$17K = $8K. And since $8K / $80K = 10%, Mr. PoP will still qualify for his full employer match. (Remember his match maxes out whenever he puts at least 6% into the account.)
This is what the maximized setup would look like:
|Mrs PoP||Mr PoP|
|Employee Contribution||23% = $17K (2012 fed max)||10% = $8K|
|Employer Contribution||25% uncapped = $4.25K||50% capped @3% = $2.4K|
Our combined employee + employee contributions would become $31.65K, which is $1.45K more than it was in the previous scenario!
What’s the Downside?
The main downside is that Mr. PoP’s 401K balance would grow more slowly than mine, at least until we start increasing our overall contribution and work on maxing out both accounts up to the federal limit of $17K. In the meantime, Mr. PoP is going to have his annual increase changed from 2% to 4% to make up for the fact that mine won’t be able to go up much (due to the federal max), so in a couple of years his contributions will be big again, too! Luckily Mr. PoP’s ego is not so big than he needs a bigger account balance in the meantime, especially because we’ve combined finances to the point that there is no “his” or “hers”, just “ours”.
Tax & Legal Implications?
One of the benefits of having colleagues who are top notch accountants is that you can ask them questions about stuff like this. So I did. Long story short, because Mr. PoP and I have similar incomes and file taxes jointly, there shouldn’t be any net effect on our tax bill at the end of the year.
As for the legal implications of having more going into an account in my name, I asked about the worst case scenario. What are the consequences of this move if our marriage fails. My accountant buddy says he’s seen that happen before, and the parties (who weren’t having a contentious divorce) were able to easily roll funds over to an IRA (Individual Retirement Account – another type of retirement account with preferential tax treatment) for the partner with the smaller balance to make sure that the split was equitable. There are apparently ways to do so without creating a taxable event should the situation arise. [PoP fans, don't worry - our marriage isn't having problems, just making sure we've CYA, ya know?]
We’re making the changes now, so they should go into effect next month. And while the extra ~$1.45K is relatively minor compared to the $30K+ that we put into our 401Ks each year, we’re looking forward to maximizing the benefits that our employers offer us by working as a team.
*There is a federal cap on 401K employee contributions for tax purposes. In the 2012 tax year, that amount is $17K.
**Vesting schedules can be another matter to consider. I don’t really mention it here – ours was made simpler because I am more vested as I’ve been with my employer longer than Mr. PoP has been with his.
Have you taken a look at how your retirement accounts look together with your partner’s? Are you maximizing your employer matches as a team?