Fisher Price 401K

January 18, 2007 11:09 AM

No-nonsense 401k - I just wanted to get one up and running to take advantage of employer matching. So what does the following mean...?

"The employer will make matching contributions equal to 50% of your 401(k) before-tax deferrals and your employee after-tax contributions, for the first 8% of your compensation that you contribute to the Plan."

I don't know what the difference between before-tax deferrals and after-tax contributions is. If I wish to take the road most travelled, should I just elect 8% of my after-tax contributions?

posted by The_Partridge_Family to Work & Money (12 answers total)

I would definitely advise contacting your employer's human resources or retirement services contact, as the verbage in the details of every plan are better explained by these types of folks, or so I've found.
posted by Asherah at 11:15 AM on January 18, 2007

Pre-tax deferrals are deducted from your paycheck before your income tax is withheld, making your overall income tax less. Post-tax contributions would be money you just put in out of your checking account (or whatever) that's already been taxed. If you have a regular 401K, the money in it would just be taxed again when you withdraw it at retirement, so most people (that I know) only make pre-tax deferrals. Otherwise, you're essentially paying taxes on the same money twice, when you could just be paying it once.

Your employer will match 50% of whatever you put in, up to 8% of your gross salary. So, the max they'll basically contribute is 4% of your gross salary.
posted by LionIndex at 11:20 AM on January 18, 2007

You should contribute 8% of your salary as a before-tax deferral to maximize the employee match. You can contribute more but it won't be matched.
posted by smackfu at 11:20 AM on January 18, 2007 [1 favorite]

So say you make 100k/year gross salary. Typically you are taxed on all of that, say at 25% (not accurate), so taxes would be 25k. If you contribute 8k (8%) pretax, according to the IRS, you're adjusted income is now only 92k, which would lower your tax burden by 2k in this case. In addition to saving on taxes, you also would receive the employer match of half of your input, so 4k. So at the end of the year, you've basically been given 6k in money in exchange for the forced savings.

As far as contributing above and beyond the match, what I've heard (but am not sure about) is that there is a 15k limit to contributions. So you can keep saving on taxes by putting in up to 15k, even though your employer won't match. I'm not positive on this part, so I'd talk with HR about that one.
posted by cschneid at 11:26 AM on January 18, 2007

Cold, hard numbers:

Say you make $50,000 annually. If you contribute 8% of your income to the 401K as pre-tax deferrals, you'll be contributing $4000 a year, and your salary as far as the IRS is concerned is $46,000, meaning that you end up paying less in income tax. If you make post-tax contributions, you'll be taxed on the full $50K, or have to go back and do your contributions as income tax deductions when you file your return (similar to what you would do with a traditional IRA). It's generally much easier to just do the pre-tax deferrals.

It sounds like whatever you do, your employee matches 50% of whatever you put in up to 8% of your salary, meaning that if you're making $50,000, at most they'll pay $2000. $6000 would be your total 401K investment.
posted by LionIndex at 11:32 AM on January 18, 2007

@cshneid: Subject to certain additional limits (I think), the employer's matching contribution to an employee's 401k plan is not subject to the 15k limit on employee's direct contributions. Makes it an EVEN better deal if your employer matches and you want to contribute as much as possible.

Also, don't mix pre-tax and after-tax contributions in the same account - it's a nightmare. And definitely don't do after-tax contributions at all until unless you are hitting AMT or maxing out pre-tax or some other legitimate reason for not taking advantage of all the pre-tax benefits.
posted by jcwagner at 11:56 AM on January 18, 2007

Max out a Roth IRA before you even begin to consider starting to think about making after-tax contributions to your 401k.
posted by Uncle Jimmy at 12:11 PM on January 18, 2007

You want it simple? Contribute 8% of your salary as a before-tax deferral. That is the most bang for your buck.
posted by ND¢ at 12:16 PM on January 18, 2007

One thing that isn't clear to me is if the after tax contributions are to a Roth 401K. If that is an option, you may find it to your advantage to put in after tax money now and withdraw it tax free when you retire.
posted by advicepig at 12:26 PM on January 18, 2007

Uncle Jimmy, you're failing to take into account the very high-income person who is still eligible for a match after maxing out his tax-deferred limit. For example, take the $300,000 a year earner. He is eligible for a $12,000 match on $24,000 of his salary, but he can't contribute $24,000 pre-tax to a 401(k); he can contribute only $15,000.

If he fails to contribute the remaining $9K after tax, he's throwing away $4,500 in match, equivalent to an immediate 50% return on investment. Roth IRA doesn't beat that.

smackfu's right, by the way.
posted by ikkyu2 at 1:12 PM on January 18, 2007

Smackfu is right, but don't make the mistake a lot of people do and get too wrapped up in the amount of the match. 401k contributions are a good idea regardless of a match - the only thing you're haggling over is how MUCH of a chump you are if you don't take advantage of your 401k.

Any contributions you make (up to an amount of money that few people have to worry about surpassing) are pre-tax, meaning that the $1 you elect to put in really only impacts your paycheck about $0.75 - $0.85 (assuming you're one of the most of us who earn under $123,000 in adjusted gross income a year).

Some - like myself - would argue that therefor you're probably realizing a gain effectively immediately. You WILL pay taxes eventually when you withdraw that money, but there's a good possibility you'll be at a lower tax rate at that point since you'll be retired. If you contribute money that you'd be paying 25% on now and later withdraw it and pay 15% at that time then you've made 11% instantly.

So by that metric you're a chump if you don't contribute money you can afford to, period.

Adding the match you move to a bigger level of chump if you don't take advantage. With a 50% match a $1.50 contribution into the account only cost you $1 of your income, with $0.75 to $0.85 actually being out of your pocket. If you put in a 25% taxed dollar and eventually withdraw that $1.50 at a 15% tax rate you'll get $1.28, a 70% return.

That's $1.28 you get even if the account never earns a penny of interest (rather than the 11% average the market grows every year). With compound interest on that 11% annual gain every additional penny you put in up front make a tremendous difference long-term.

So there's chump and there's CHUMP. Personally I suggest you don't be either kind.

Regarding the Roth vs post-tax contribution, I notice that nobody has mentioned the fact that you're ineligible to contribute to a roth if you have an employer-sponsored retirement plan (ie, a 401k) and are over a certain gross yearly income. In addition to the thrown away match ikkyu2 mentions there's the simple matter that his example person CAN'T have a roth.
posted by phearlez at 2:32 PM on January 18, 2007

there is a 15k limit to contributions

$15,500 for 2007.
posted by Heywood Mogroot at 10:46 PM on January 18, 2007