The new year has arrived and, with 2011 in full view, you may be faced with the question: Does it make sense to defer the maximum limit of $16,500 (or $22,000 if you are over age 50) into your 401(k) plan, as early as possible or is it better to spread it out over the entire year? Some of us like to get the full deferral out of the way and into the plan as soon as possible to achieve the longest period of investment towards retirement. However, I think the more important question to ask yourself should be: How does the employer match work in my plan? More specifically, does my plan "true up" employer matching contributions by plan year or by payroll??
If you know the answer to this question, you are already ahead of the game. If you are not sure of this answer, now may be the time to find out.
A plan that provides an employer match "true up" based on the plan year will determine your total annual matching contribution at the end of each plan year, thereby mitigating any effect to the timing of when you choose to defer the limit into the plan.
However, a plan that calculates the employer match "true up" based on a payroll-by-payroll basis can produce different results depending upon when you make your deferrals.
Let's take a look at a plan that matches employee deferrals payroll by payroll. In this example, we ll assume the plan matches 50% on the first 6% of employee deferrals per payroll. We also use higher dollar values, to help illustrate the concept.
Participant A has an annual compensation of $400,000 and defers 10% of his or her compensation during the first 11 of the 26 payroll periods for the year until the $16,500 limit is reached. The employer match on each payroll is limited to 50% of the first 6% deferred. The participant's deferral amount from each paycheck is approximately $1,538.46. The approximate match for each paycheck is $461.54. This amount is credited for 11 payroll periods, resulting in a total matching contribution of $5,076.83 for the plan year.
Participant B has the same annual compensation of $400,000 and defers 6% during the first 18 of the 26 payrolls for the year until the $16,500 limit is reached. Again, the employer match on each payroll is limited to the same 50% of the first 6% deferred. The participant's deferral amount from each paycheck is $923.07(and slightly less on the 18th check). The approximate match for each paycheck is again $461.54. This amount is credited for the 18 payroll periods (but slightly less on the 18th check), resulting in a total matching contribution of $8,250.00 for the year.
In this example, Participant B received a difference of approximately $3,173.17 in additional matching contributions compared to Participant A. This demonstrates how timing matters if your plan determines employer matching contributions on a payroll-by- payroll basis.
If, on the other hand, our hypothetical plan determined a true up match at year end, both Participant A and Participant B would have received the same matching contribution. Specifically, at the end of the year, Participant A would have received an additional matching contribution of $3,173.17 to true up their match.
So, the question remains: How do you plan to defer for 2011 into your retirement plan? Make sure you know how your plan determines the employer matching contribution when you are planning your 2011 deferrals.