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Boost Your Savings with a Raise

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Andrew R. Michaud

• October 06, 2023

I recently received exciting news - starting in November, I will be receiving a nice raise. With this increase in income, I see a golden opportunity to enhance my savings. What makes it even better is that I won't even feel the impact of saving more. Additionally, I already have some cash saved up at my bank. One of my goals is to maximize my 401(k) contributions. However, since the raise won't come into effect for a while, I'm not sure if I should just write a check to the plan.

Making the Most of Your Raise

Dear Todd,

Congratulations on your well-deserved raise! Your approach to saving is commendable, as saving all or a portion of your raise is an excellent way to bolster your savings. Since you're not accustomed to relying on this additional income yet, it's a great opportunity to put it towards your financial goals.

Navigating Contribution Limits for Your 401(k)

To contribute to your 401(k) plan, also known as "employee deferrals," you need to go through payroll deductions. It's not as simple as writing a check. In order to maximize your contributions to the 401(k), there are certain limits to be aware of.

The maximum dollar limit for employee deferrals in 2023 is $22,500. If you're over the age of 50, you have the option to contribute an additional "catch-up" amount of up to $7,500, bringing your total contribution potential to $30,000.

However, instead of specifying a dollar amount, your employer may have asked you what percentage of your pay you'd like to contribute. The tax law technically permits participants in a 401(k) plan to contribute up to 100% of their earned income, but most plans have guidelines that prevent such high deferral percentages.

The specifics of what you can do depend on the provisions set by your particular plan. Several plans impose a limit on the percentage of your pay that can be deferred during each pay cycle. For instance, if your plan restricts the deferral percentage per pay period to 15%, you won't be able to contribute more than that.

Additionally, while some plans allow for changes at any time, others have more rigid rules. Smaller companies, in particular, often limit changes to elective deferrals to specific frequencies or designated dates. At some companies, it may take a pay period or two for changes to come into effect.

Nevertheless, it is still possible to maximize your elective deferrals even if you can't directly write a check. Although the process might be different, the end result will be similar. Here's what you can do.

Remember, with your raise comes a wonderful opportunity to boost your savings and set yourself up for a more secure financial future. Take advantage of this exciting moment to make significant progress towards your goals. Good luck!

Maximizing Retirement Contributions

One key aspect of retirement planning is maximizing your contributions to ensure a comfortable future. By following a simple calculation process, you can determine the additional amount you need to save in order to reach the maximum contribution limit.

To begin, subtract your current annual contributions from the maximum allowed limit, which is $22,500 (or $30,000 for individuals over 50). The remaining amount represents your goal for additional deferrals.

Next, divide this goal by the number of pay periods remaining in the year. This will give you the dollar amount you should contribute per pay period. To make this calculation easier, you can also convert this dollar amount into a percentage of your income.

Let's consider an example. Suppose you will fall short by $6,000 of reaching the maximum contribution at your current salary and savings rate. With six pay periods remaining, you will need to save an extra $1,000 per pay period to maximize your contributions. By converting this amount to a percentage of your income, you can increase your savings rate accordingly.

Keep in mind that if you make a Roth or after-tax contribution, your take-home pay will decrease by $1,000 per pay period. However, if you contribute pre-tax, the decrease will be less than $1,000. To counterbalance this reduction in take-home pay, you can tap into your bank account to cover the difference each pay period. By the end of the year, you will have successfully maximized your contributions, and your bank account will reflect a decrease of $6,000 (or less if making pre-tax contributions). This approach allows you to achieve a similar outcome as if you had been able to write a check for the additional amount.

Remember, it's important to consult with a financial advisor to determine the best strategy for your individual circumstances. By taking proactive steps towards maximizing your retirement contributions now, you can secure a brighter financial future.

Image by Gerd Altmann from Pixabay