401(k) front-loading & employer match optimization

401(k) front-loading & employer match optimization

Are you considering front-loading your 401(k), but are unsure of how that affects your employer’s matching contribution? I was, so this post digs into the details. You’ll see three ways to max out your 401(k), and learn how they mesh with three types of employer matching.

As you can see in our Investor Policy Statement, we prioritize maxing out our tax advantaged accounts. We could take things a step further by front-loading those accounts early in the year. The Mad Fientist has previously covered the benefits of front-loading a 401(k). In my case, my company matches 5% as long as I contribute at least 5%. But in months that I don’t contribute, for example if I front-load all of my employee contributions early in the year, I don’t receive the match until early the following year. This is called an annual true-up. Employers may handle true-ups in three different ways: no true-up, annual true-up, and every payroll true-up. How does the true-up influence front-loading? Read on.

Disclaimer: this post is for demonstration and educational purposes only. You should discuss your investment strategy with a trusted adviser. Do not consider this post, or the downloadable spreadsheet, as specific or individual advice.

Inputs for the 401(k) front-loading demonstration

To evaluate front-loading with the different true-up options, I had to use a single set of inputs. You can find them here and in the downloadable spreadsheet.

  • Gross salary: $100k (just an example–not my actual salary)
  • Max employee contribution that is matched: 5%
  • Max employer match: 5% (i.e. the employer matches 100% of 5%)
  • Max % of salary that can be contributed: 75%
  • Number of pay periods per year: 24 (bi-monthly)
  • In the case of an annual true-up, the true-up occurs three pay periods into the following year (i.e. mid February)
  • The employee maxes out their contribution to the IRS limit
  • The projected IRS limits for 2020 were used (it is already well into 2019, so the opportunity for front-loading has mostly passed)
  • Growth is constant throughout the year. (In reality, the actual sequence of returns influences the benefits of front-loading. Front-loading improves returns more if the funds perform better later in the year. The opposite happens if the funds dip later in the year. The longer you maintain a given approach, the more likely you will realize the long term trends of the market/funds. Hopefully you are investing in funds with positive expectation.)

Make sure to review your 401(k) plan document for true-up details before front-loading

Make sure you understand your 401(k) plan’s true-up policy before front-loading. If the plan doesn’t have a true-up provision, or the true-up provision has terms that are unfavorable for your situation, front-loading may not be beneficial. For example, if the plan only makes true-up contributions if you are employed at the true-up date, it may be best to make sure you receive the full match for every pay period (i.e. use “uniform contributions” or the “front-load contributions hybrid” approaches). The rationale being that employer matches represent part of your compensation–and guaranteed returns–that you want to capture regardless.

Side note–I actually couldn’t find the true-up info in my 401(k) plan documents, and had to contact our plan administrator. Don’t be shy if you have the same trouble.

Download the 401(k) front-loading calculator and run your own numbers

You can download the spreadsheet used for this post below. The “inputs” tab let’s you input your own 401(k) plan details. The “summary” tab displays the graphs shown in this post. The remaining tabs show the employee contributions, employer contributions, and growth calculations. The Excel future value fv() formula calculates the growth for each pay period’s contributions on a bi-monthly basis.

Scenario 1: No true-up on front-loaded contributions

Not having a true-up is the least favorable scenario for front-loading; to get the full employer match, you’ll need to make sure you make the maximum matched contribution every pay period. Here are two ways to go about this:

  • Make uniform contributions every pay period. For the projected 2020 employee contribution limit ($19.5k) and for 24 bi-monthly pay periods, each contribution would be $812.50.
  • Use a hybrid front-loading approach. At the start of the year you make maximum contributions, but drop to the maximum matched contribution at the correct time and continue to make this contribution for the remainder of the year. The contributions in this scenario depend on your circumstances, so check out the download above.

The graphs below show the contribution schedules for both approaches. Later in the post I show how all of the scenarios compare in terms of final account value.

Employee and employer 401(k) contributions are made uniformly through the year
Employee 401(k) contributions are front-loaded to a point, and then reduced to capture the full employer match

Scenario 2: Annual true-up on front-loaded contributions

Having an annual true up is the next best scenario for front-loading; you get the full employer match regardless of when you max out your employee contributions. The only downside is that the true-up comes as a delayed lump sum, meaning part of your employer contributions don’t have time to grow throughout the year. Here you can still use the uniform or front-load hybrid approaches above. In addition, you can do normal front-loading and then just wait for the annual true-up. The graph below shows the employee and employer contributions for the latter approach.

Employee contributions are front-loaded and then the bulk of the employer contributions are made in an annual true-up

Scenario 3: Every payroll true-up of front-loaded contributions

This is the best scenario. The employer makes true-up contributions every payroll period, regardless of when the employee made their contributions. This means you can front-load your contributions and still receive the full employer match during the remainder of the year. The graph below shows the contribution schedule for this scenario. Of course, the uniform contributions and hybrid approaches are still possible, although they are less favorable (see next section).

Employee contributions are front-loaded and they employer contributions are trued-up every payroll period

The overall performance of each approach

The graph below shows the final value of each approach, at the time of the annual true-up, for various investment growth rates. Assuming constant growth throughout the year (an acknowledged unrealistic assumption), uniform contributions perform the worst and front-loading with an every payroll true-up performs the best (if you’re lucky enough to have this scenario).

Account value comparison for the different contribution approaches

The front-loading with annual true-up and front-loading hybrid approaches are similar for the inputs used. The relative performance depends on the amount the employer matches. If the employer match is lower, front-loading with annual true-up becomes more favorable because there is less benefit from capturing the employer contributions along the way. Conversely, if the employer match is higher, the hybrid approach comes out ahead. To run your numbers, download the spreadsheet above.

Our current approach, and will we change?

Currently my wife and I both use the uniform contributions approach to max out our 401(k)s. Until building the spreadsheet and running the calculations, I wasn’t sure whether front-loading would be beneficial. It is clear that over the long run, front-loading would increase returns.

Are we going to change? For now, no. The reason being that we are also saving for some other lifestyle (and investment) goals outside of retirement accounts. Specifically, we are looking to use our house as a rental and move into a new house in a more favorable location. That means we need to save up another down payment. Since lifestyle choices trump investment efficiencies in my opinion, we are skipping front-loading for now.

When would we switch to front-loading?

  1. Once we have saved up enough for the down payment and would just invest our excess savings in a taxable brokerage account. This follows the logic in the Mad Fientist post.
  2. If we ever plan to work less than a full year. In this case, contributing the full employee amount is most important.

Hopefully this helps you with your front-loading decision. The differences aren’t huge, and maxing out your 401(k) is more important than how you do it.

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