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[Video] High-Income Earner’s 401(k) Mistake

by Financial Design Studio, Inc. / September 21, 2020

[Video] High-Income Earner’s 401(k) Mistake

We all know that each year in our 401(k) we have a maximum amount we can save.  For this year, for example, let’s say that the maximum amount is $26,000.  Typically at the beginning of the year, you look at how many pay periods you have.  To make it simple let’s say you get paid once a month.  You divide by the twelve different months you have. During the year you know that when you get to the end of the year you will fully fund this $26,000 that you can contribute.  You start at the beginning of the year and begin to fill it up.  For example, you fill up most of the year, but what most people may not be aware of is if you make too much money you cannot put in the full $26,000 or you may not be able to.  

Let me draw a different diagram,  and let’s say at the same time you start with nothing.  You have put nothing in the 401(k) and you haven’t earned anything.  This bar represents your salary plus bonus.  So as you go throughout the year you’re earning money and this bar represents your 401(k) contributions, so this is money you are putting into your 401(k).  The goal is to get to the end of the year and put in the maximum amount.  This is the employee contributions that you are putting in.  But, one thing you could get stuck on is if you go throughout the year and at this same point here you reevaluate and you say I have put in $24,000. Once you’ve earned $285,000 (Salary and bonus combined) throughout the entire year you actually have to stop contributing to your 401(k). You’ve made too much to keep contributing.  Once you make more than $285,000 not only can you not put your employee contributions into the 401(k) but your employer cannot continue to contribute for you either.  So what is very important if you are a high income earner that you’re actually making sure before you earn this $285,000 you are maxing out your employee contributions.  This may look like front loading here in the beginning of the year to put in all of the $26,000 if that’s the annual maximum contribution. But you need to know you will fully fund your 401(k) before you get to this income amount.   

We want to be sure you’re thoughtful of these things, because this is a really uncommon thing to think about unless you are a high income earner.  This is something you could get stuck with and not know it until the first year you have to stop contributing therefore learning the hard way.  This is a great way for you to lower your taxable income so we want to make sure you are maximizing your benefits where you can.  If we can help you stay on track please reach out and let us know.  

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Financial Design Studio, Inc.

We are financial advisors in Deer Park and Barrington, IL. A team with a passion for helping others design a path to financial success — whatever success means for you. Each of our unique insights fit together to create broad expertise, complete roadmaps, and creative solutions. We have seen the power of having a financial plan, and adjusting that plan to life. The result? Freedom from worrying about the future so you can enjoy today.