Get the Most Out of Your 401K Contributions with a 401K True Up
401ks are a great way to save. Investing in a 401k lowers employees' income taxes, creating a retirement nest egg. However, it can be challenging to ensure you receive the maximum matching funds from your employer.
Companies use True Ups to reconcile the matching funds an employee receives with the matching funds they are owed.
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What Is a 401k and How Do I Invest
A 401k is a retirement savings account named after section 401(k) of the Internal Revenue Code. Employees contribute a sum of their pre-tax paycheck to the fund, and, traditionally, their employers match up to a certain percentage of the individual worker's salary.
Employer Matching Funds
Employers establish a percentage of your annual income they are willing to match, fittingly called an employer match. Once they have paid that amount into your account, the company stops matching funds, regardless of what you continue to contribute.
Earning Matching Funds
Employer matching contribution of funds in two primary ways:
- One hundred percent match: Employer matching contributions won't go beyond the pre-established percentage of your annual salary. A 100 percent match, or a full match, means the company meets your contributions until you have reached the cap. Companies stop matching the funds once the limit has been reached.
- Partial matching: Some employers only match a portion of your contribution while maintaining the annual salary percentage cap. Because the company is only paying out a percentage of your contribution, you will need to contribute more money to reach the maximum matched amount.
Contributing Too Little
There's a maximum amount your employer will match. If you do not contribute that much, you are essentially losing money. Be sure to contribute enough to meet the maximum percentage of your annual salary your employer will match.
Contributing Too Much
Because 401k funds are pre-tax, there is an IRS maximum contribution limit that limits how much you can contribute annually. As a result, higher salaried employees typically fully fund their 401k quicker.
Since employers contribute matches based on a maximum percentage of your paycheck, if you reach your cap early and do not contribute to the fund the rest of the year, the company stops paying their matching percentage, and you lose that potential money.
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What Is a 401k True Up?
True Ups reconcile disparities in accounting, specifically when the employer owes matching funds to an employee at the close of the fiscal year. A True Up ensures you get all of the matching funds available.
How True Ups Are Determined
Employers determine whether or not a 401k True Up is needed based on the following factors: previous annual income, deferrals, and the company's matching formula.
There are two determining elements in True Up consideration. Those are whether your employer utilized Per-Pay-Period Matches or an Annual Basis.
Many companies employ a per-pay-period match program. Per-pay-period match means employers invest their matching funds each pay period, not necessarily when you invest your funds.
Employees who intend to max out their 401k need to decide if they would rather want to make consistent 401k contributions through the year or frontload their contributions to max out early.
- Consistent 401k contributions through the year: Making steady and regular deposits each payday assures your employer matches the maximum amount on your 401k.
- Maxing out your 401k contributions early: Employees may opt to frontend their 401k contributions. While maxing out early ensures you will meet your cap, if your employer uses per-pay-period matches, they will stop contributing once you've maxed out, even if there are remaining pay periods in the fiscal year.
True-Up Contributions Using Annualized Matching Calculation
The annualized matching calculation ensures that the per-pay-period match equals the maximum annual contribution. Employees who frontload and fail to receive matching funds after maxing out are eligible for True Ups for the difference.
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Administrators work behind the scenes on 401k accounts. The maintenance and management of these funds accrue certain fees. These are:
- Investment Fees: Investment fees cover the costs of any mutual funds your money is invested in and a financial advisor. These charges are typically an overall percentage of the investments.
- Administration Fees: Administration fees get paid to third-party companies who manage the everyday maintenance of your account, including record-keeping, compliance-testing, and reporting
- Individual Services Fees: These fees get charged for one-time occurrences.
- 12b-1 Fees: 12b-1 fees cover the cost of mutual funds and pay salespeople.
How Companies Benefit From a 401k True Up
Employers can deduct their 401k contributions from their federal income taxes. True Ups and 401ks help companies attract highly qualified candidates who expect quality retirement compensation.
Employees are also more likely to remain at a job where they have already built a solid 401k.
How Employee Participants Benefit from a 401k True Up
True Ups allow employees greater control over how they choose to max out their annual contributions. If you frontend, you max out your contributions before your company has reached its maximum matching, and a True Up allows you to receive the funds you've missed.
Additionally, if an employee's contributions change, True Ups will enable the reconciliation between matching funds the worker received versus the amount owing to them.
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401k True Up Contribution FAQ
Do you have any more questions about how the 401k True Up works? Here's a look at some commonly asked questions.
Are 401K True UPS Required From Employers?
While many employers choose to provide True Ups, Federal Law does not require them.
What Does Year-End True up Mean?
Year-End True Ups reconcile any matching funds an employee didn't receive, up to the maximum percentage a company offers.
Can an Employer Stop Matching the 401K Contributions?
Yes, employers can stop matching 401k contributions at their discretion. Usually, companies will only do so when financial difficulties dictate the cessation.
When Did Companies Start Matching 401K Contributions?
The Revenue Act of 1978 signaled the start of companies matching 401k contributions. Congress amended the Internal Revenue Code so that employees would not be taxed for deferred compensation.
True Up Contribution: Key Takeaways
A 401k is a valuable tool for retirement savings. Talk to your employer about whether or not your company offers True Up reconciliation to assure you receive the maximum matching funds and plan your contributions accordingly.