June 14, 2018
Company 401(k) contributions are one of the most valuable retirement perks offered by employers, but unless you understand the nuances of how your company’s plan works, you may miss out on key benefits.
Many professionals assume it’s both saving-savvy and financially proactive to save more in your company 401(k) earlier in the year. The sooner you get the money in your 401(k), the more time the funds have to grow, and the more tax-deferred earnings you save over time, right? Not always…
This approach may work for those saving in a company plan that offers an employer match accompanied by a true-up provision, but it doesn’t work for everyone.
In fact, I recently worked with a new client who had been employed at BMC Software for over 10 years. He used the “save more, save early” approach when determining how he would disperse his contributions throughout 2017. Let’s call this client ‘Paul’.
As part of our comprehensive planning process, we reviewed Paul’s 401(k), the BMC Software Inc., Savings and Investment Plan. We sifted through quite a bit of data, including his 2017 year statement—and that’s where we noticed he only received 1.6% of his income in matching employer contributions when he was eligible to receive up to 5% per year. We immediately identified this as a red flag, as we work with a number of new clients from BMC who, like Paul, are misled by similar generalizations.
Due to the way Paul contributed to his plan, he only received $4,583 from BMC, when he was eligible to receive up to $13,750.
That’s a $9,167 difference in his annual savings!
We didn’t go back and check, but based on how Paul has been telling us he contributed, we’re fairly positive he had been missing out on the ‘free’ $9,167 for several years. The important takeaway from Paul’s situation — one we actively communicate to clients — is the importance of following a financial road-map custom to you and your retirement journey. The end goal is to create a comprehensive plan that facilitates a tax-advantaged retirement future while making the most of your employee benefits along the way.
However, this can be a challenge for professionals like Paul who may not have the time to manage their career while ensuring their financial strategy capitalizes on every opportunity in their employer’s retirement plan. Let’s walk through Paul’s situation and some of the math behind his unrealized employer contributions to better understand why he missed out on these funds and how he can take full advantage BMC’s benefits going forward.
What to Consider When Contributing to Your Employer’s 401(k) Plan: Employer Matching Contributions, IRS Limits, the True-Up Provision, & Where You May be Missing Out on ‘Free’ Money
Why was Paul’s company 401(k) contribution strategy a dilemma? To understand why front-loading his contribution was limiting, it’s necessary to understand BMC’s benefits plan and how that impacted Paul’s saving strategy when contributing to BMC’s 401(k) plan.
First, it’s important to note that page 42 of BMC’s 2017 US-Benefits Guide states, “BMC matches 100% of every dollar you contribute, up to 5% of your eligible pay each pay period.” In other words, Paul must contribute every pay period to receive a match every pay period, and BMC will only contribute a match of up to 5% of Paul’s income for each corresponding pay period in which he saves in the BMC plan.
To get the 5% per paycheck match, Paul must contribute at least 5% of his income that pay period to his company 401(k). So, if he only contributes 3%, he will only get a 3% match from BMC. In contrast, if he contributes 21%, BMC will still only match up to 5% of his income for each pay period in which he makes the 21% contribution.
Further, BMC’s employer contribution rule is clearly stated on page 42 of the company’s benefit book, “…as soon as your contributions reach the annual IRS limit ($18,000 in 2017, $18,500 in 2018), your contributions and matching contributions will end.”
In light of this rule, it’s also important to remember that the BMC Software Inc., Savings & Investment Plan is a per paycheck matching plan without a true-up provision.
So, if an employee reaches the annual IRS contribution limit within the first few months of the year, they will be restricted from making any future contributions and will not receive an employer match for the year’s remaining pay periods. In addition, BMC will not reimburse the employee, or ‘true-up’ the difference in missed contributions at the end of the year, which is why it’s necessary for employees like Paul to have a firm grasp of their plan’s unique stipulations. Once the matching opportunity is missed, there’s no going back, and years of overlooking these benefits can be a hard pill to swallow.
Let’s take a deeper dive into Paul’s predicament and break down some of the math involved…
⇒ Paul’s Annual Income/12 Months = $270,000/12 = $22,916.67/month.
⇒ The maximum BMC is going to contribute to Paul’s 401(k) per month is 5%, or $1,145.83/month.
⇒ BMC Matching Contribution per Pay Period X 4 Months = $1,145.83 X 4 = $4,583.33.
What happens to Paul’s contributions from January to April 2017?
For the first four months of 2017, BMC was contributing, $1,145.83 per month. After April, neither Paul nor BMC were able to contribute to his BMC Software Inc., Savings and Investment Plan for the remainder of 2017. Why? Once Paul’s contributions reached the annual IRS limit ($18,000 in 2017) his contributions and BMC’s matching contributions end.
Therefore, if Paul maxes out the IRS pre-tax $24,500 pre-tax and catch-up contribution limit by April, he does not receive an employer match for the rest of the year. As noted previously, BMC’s retirement plan does not include a true-up provision. Even though BMC’s matching contributions are cut short, the company will not compensate Paul for the money he could have received had he not maxed out his contribution limit so early in the year.
To reiterate, when Paul contributed to the BMC plan, he only received $4,583 in matching contributions from BMC for the entirety of 2017, when he could have easily received nearly $14,000. Had he known about the fine print in his employee benefits book, Paul could have accumulated thousands of dollars more per year, not including the corresponding tax-deferred earnings.
How Can You Distribute Your Annual 401(k) Contributions to Receive the Full Employer Match?
What should Paul do to maximize his annual contributions to his BMC Savings and Investment Plan for the 2018 year? First, he needs to determine the best way to distribute his contributions throughout the year so that he is contributing at least 5% of his income per pay period to his employer plan. Let’s walk through how he can do this.
BMC knows their matching contribution set-up is confusing and employees inadvertently miss receiving employer dollars as a result. To help solve this problem, they built the BMC 401(k) Deferral Calculator so employees can better estimate how to maximize their employer contributions. The BMC 401(k) Deferral Calculator is one of the easiest ways to do this. Paul can simply go to the website, enter his info, and the calculator will make recommendations specific to his situation similar to the results below.
Another way Paul can calculate his recommended contribution is by dividing the maximum annual pre-tax contribution ($18,500 for 2018) by the lessor of his annual income, or the IRS 401(a)(17) employee contribution limit ($275,000 for 2018):
⇒IRS Annual Pre-Tax Contribution Limit/Paul’s Annual Income = $18,500 / $275,000 = 6.73%
Since the BMC Savings Plan only accepts contribution increments of 5%, Paul should set his annual allocation to be 7% for the year. This way, he reaps the benefit of a 5% employer contribution all year.
*Note: We recommend our clients annually adjust their 401(k) contributions at the very beginning of the year for simplicity. We generally assist them to make the changes annually.
The True-Up Provision and Overlooked Employee Benefits
Not all matching plans are as complicated as the BMC Software Inc., Savings and Investment Plan. Some plans have a true-up provision that ensures the company will ‘true-up’ any missed employer contributions at year’s end, even if an employee front loads their contribution at the beginning of the year. What’s nice about plans with a true-up provision is that as long as you’re maxing out your employer plan contributions, you’re also receiving the most money possible from your employer’s contributions.
According to a 2015 report, only 45% of employers that match contributions have a true-up provision in their employer-sponsored retirement plan!
This means nearly half of employees saving in an employer 401(k) do not have the safety net of a true-up provision and may risk making the same mistake as Paul. However, let’s be honest, who actually reads their company’s employee benefits book (other than us)?
*Note: if a company’s benefits plan includes a true-up provision, we still normally recommend that our clients disperse their contributions throughout the whole year so that they don’t wait untill year end to receive their employer’s matching contribution.
Simple Contribution Plans and the Shell Provident Fund
In my opinion, the simplest and best 401(k) plans are those where the company makes a simple contribution to an employee’s 401(k) plan that is independent of the employee’s contribution.
For example, if you have been employed with Shell for nine years or more, the company will contribute 10% of your eligible pay to your employer-sponsored 401(k) plan, also known as the Shell Provident Fund. It doesn’t matter what amount you contribute to the 401(k) or when you make the contribution. If you are eligible, Shell will contribute 10%.
Unfortunately, not all plans are as easy to manage as the Shell Provident Fund and require knowledgeable management to fully take advantage of the employee benefits offered. Expert advice can help you identify the discrepancies and limits your company 401(k) plan entails, and leverage a contribution strategy that maximizes your annual retirement savings. Before you make a final decision, consult your financial advisor for advice, or meet with one of our financial professionals to get a second opinion on your company 401(k) contribution strategy.
Nick Johnson, CFA®, CFP®
Nick Johnson believes that financial planning is more than numbers on a balance sheet and a standardized process. People are unique and should be treated as such.
As Vice President and Wealth Manager at Willis Johnson & Associates, his goal is to really get to know his clients, all the while providing a proactive approach to comprehensive wealth management.
Willis Johnson & Associates is a registered investment advisor. Information presented is for educational purposes only. It should not be considered specific investment advice, does not take into consideration your specific situation, and does not intend to make an offer or solicitation for the sale or purchase of any securities or investment strategies. Investments involve risk and are not guaranteed. Be sure to consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed herein. Insurance products and services are offered or sold through individually licensed and appointed agents in various jurisdictions.