How to Cap Out on a 401(k)

Capping out your 401k lowers your tax bill.

The high contribution limits and ease of participation makes the 401k one of the most powerful retirement savings vehicles available to the average employee. If you have the income and the cash flow to do it, maxing out your 401k contributions makes a lot of sense. Capping out your contribution lowers your current taxes, while allowing you to set aside more money and have it grow tax-deferred all the way out to retirement.

Things You'll Need

• Contribution change form
• Calculator
• Pay stub

Instructions

1. Decide whether you prefer to have your 401k contributions spread evenly throughout the year or front loaded to get your maximum contribution in as quickly as possible. If you choose to front load your contributions, you may be able to cap out your 401k relatively early in the year, especially if you are a high earner. But you could experience cash flow problems, since a high percentage of what you earn would be going into the 401k.

2. Divide the total allowable 401k contribution by the number of pay periods at your company. If you get paid twice a month, you would use 24. If you are paid every two weeks, you would use 26 instead. For 2011, you can contribute up to $16,500 to your 401k plan, plus an extra $5,500 if you are 50 or older. Divide that number by the number of pay periods to determine how much you need to contribute each pay period to max out your 401k by the end of the year.

3. Calculate the percentage of your income you need to divert to the 401k to meet your goal of capping out the plan. For instance, a worker who earns $80,000 a year and is paid twice a month would need to contribute just under 21 percent to the 401k plan to max it out by the end of the year.

4. Contact your human resources department and request a contribution change form for the 401k. In some cases you may be able to make the changes online, either through the company intranet or the website of the plan administrator.

5. Keep a copy of the contribution change form for your records. Check the next paycheck to ensure that the changes have been made. If you make the change close to payday, you may not see the changes reflected until your next pay period.

References

• The Money Alert: 401k and IRA Contribution Limits
• The Motley Fool: The Birds and Bees of Your 401k