The 401(k) True Up

The 401(k) plan has become the primary vehicle for retirement savings for most private sector employees.  While these plans can take many shapes and sizes, today I want to talk about the ways to maximize a company match.

Let’s say your company is offering to match $0.50 of each $1.00 that you save up to a certain level.  For this example, this limit is 6% of your entire paycheck.

Simple enough, if you save 6% in your 401(k), your company will contribute 3% for a total 9% contribution.  As an employee, this is free money and it should be a no brainer to save at least 6% into the 401(k).  What other program gives you a 50% return on your investment as soon as you deposit the money?!

For somebody that saves that 6% from January 1^st to December 31^st, the 3% company match is pretty straightforward.  But what happens if your contribution percentage is not consistent throughout the year?

If your 401(k) plan does not have a true up feature, you could be leaving match money on the table.  So what exactly is a true up?

In the document governing your 401(k), your employer agrees to match your contribution per pay period or per year.  If your agreement indicates a match per pay period, you receive the match for the pay periods you contribute to the plan. If your agreement states per year, or what we call the “true up,” the company looks at your annual compensation, your annual contributions, and then determines the correct match.

Here are some common examples of an individual making $100,000 per year, and how this subtle language in a governing plan document can effect your company match contribution.

Example A: You are not eligible for your 401(k) plan until July 1^st, so no contributions go into the account for the first half of the year.  You save the 6% and received the 3% match for the second half of the year.  Your contribution totals $3,000, and the company matched $1,500, based on half a year’s income of $50,000.

What if you doubled your contribution rate to 12% as soon as you were eligible July 1^st?  If you have a true up feature, your match is based on an aggregate for the year, and not for any particular pay period.

In this example you saved 12% of $50,000, or $6,000 in the 401(k) plan. The company matches $1,500 (3% of $50,000).  With the true up, the company looks at the year in aggregate; You made $100,000, saved $6,000 or 6%, therefore your match should be $3,000 and not $1,500.  Your company would have to contribute an additional $1,500 to your account after the end of the year.

Example B: You max your contribution out before the end of the year.  Let’s say you make that same $100,000 and you put away the $18,500 IRS max into your 401(k) plan, and do so by June 30^th.  If your adoption agreement states your match is per pay period, your company only has to match 3% on the $50,000 you earned in the in the first half of the year, and not 3% of your entire years compensation of $100,000.  In this example, you would only receive $1,500 instead of $3,000 if you spread your contributions out for the entire year.

If you have a company match, it’s important that you understand the structure of the match or you hire a financial planner that does.