Today I had an Ah-HA moment.
Honestly, it was a face palm moment and I really did think. Why in the world did I not think of that.
Lately I have been learning a lot about finances. I’ve been getting nice and friendly with the idea of investing, and dipping my toes into optimization. So understanding the purpose and usage of a 401K has been one of them. So we finally committed to maxing out our 401K’s every year. To do that we did the math and figured out what percentage of our paychecks we had to contribute to get there.
The Problem
When we started doing this calculation we were assuming a year of contributions. Which means how do we need to spread this out in a 12 month period.
Why was this a problem?
Well we were in July not January, This means we were ignoring all the potential of this year and saying “OK, lets just make sure next year we get the $17,500 into each of our 401K.” (making and awesome plan like that is not a problem)
BUT what about this year?
This year we started with lower percentages in our 401K and just recently scaled it up to the percent we need to max out. We would have only contributed ~$13,382 and ~$9471 to our respective 401Ks. While this is a lot better then the national average it is not the maximum contribution.
These numbers leave about ~$12,000 on the table.
The Solution
So what to do next?
So I ran the numbers again (since I am the money managing being in the house) This time with the goal to max out the contributions allotted for this year, but still have enough paycheck to pay the bills for the next 4 months.
So the math looked something like this
Max contribution- $$ already contributed-$$ taken out for next paycheck= total left to contribute
$17,500- $6,969-$712=$9,819
Then divide that by the number of months left. Then divide by 2 since I get paid twice a month.
$9,819/4=$2,454/2=$1,227
This means that for every paycheck I need to be contributing $1,227 to get close to maxing out my 401K.
Well that’s all nice and dandy but my 401K works on percentages.
So now I just divide this by my paycheck gross.
$1,227/$2,299= .53 x 100=53%
So there you have it I need( and did ) up my contribution to 53% to make sure I capture as much of my tax saving 401K money as possible.
One thing you do need to think about is you do still need to leave enough money to cover all the other draws on your paycheck. For example your medical premium, taxes, FSA and such. Even adding all my other costs I will still be able to bring in a paycheck. So make sure you do that final check.
Maybe you won’t be able to max out your account this year, but if you find your self with more money because you have payed down your debts and are living more efficiently. Well I would definitely look into dropping more money into that 401K.
Another great reason to know how to do this little calculation is that if you are planning on leaving a job (for whatever reason) and don’t have another one to go to. Well you can still get all your $17,500 while you work you just do the math. Lets say I’m planning to quit work in June 2015. Well I can just divide $17,500 by 6(# of months) and then I’ll know how much I need to contribute each month so that I contribute the max.