401(k) Summer School: It Helps to Be a Little Weird Sometimes
Hi Friendos,
Today’s third installment of 401k summer school is all about how being weird can be to your financial advantage. Being “weird” is often pretty helpful in personal finance, like doing a no-spend challenge as a New Year’s resolution, taking home all the leftovers from an office catered meal, cutting sponges in half so they last twice as long (and fit better in my hand), or using homemade shampoo that costs a teeny fraction of storebought. Yep, I have done every one of those things. But today we’re here to talk about bigger $$$ amounts and retirement savings.
Lesson 3: You can use weirdly small paychecks to get a lump of cash into your 401k.
I’ve worked with multiple coaching clients who evaluated how much they really needed in their emergency fund, realized they had too much cash sitting around, and wanted to save more for retirement. The thing is, they couldn’t directly move money into their 401k because contributions can only come out of paycheck withholding. This is a problem we can work around!
I usually suggest something like this, assuming that they can change their 401k contributions at any time:
Step 1: Figure out how much extra cash you have on hand that you want to put toward retirement saving and investing. Example: you currently have $42k in the savings account you have designed as your emergency fund. You determine your monthly spending is $6k and decide you want 4 months of expenses in your emergency fund, which is $24k. You have $18k of excess cash you’d like to put toward retirement.
Step 2: Move that $18k of cash out of the emergency fund account into a side savings account.
Step 3: Identify the specific change to 401k contributions such that you’ll contribute an extra $18k year end. (1) Figure out the # of paychecks you’ll receive during the rest of the year. (2) Subtract 1 or 2 from this number, depending on processing time for any change to 401k contributions. (3) Divide $18k by this number to get a $ amount per paycheck.
- Example: you are paid every other Friday, it takes 1 pay cycle to process changes in 401k contributions, and your next paycheck will be Friday, August 14. There are 10 paychecks left this year (8/14, 8/28, 9/11, 9/25, 10/9, 10/23, 11/6, 11/20, 12/4, and 12/18) but with processing time you only have 9 paychecks where you can have additional 401k contributions taken out. That’s an additional $2k per paycheck.
- *** For the sharpshooters among you, I do recognize that this example is accurate for Roth 401k contributions but only approximate for traditional 401k contributions, because an additional $ of traditional 401k contributions reduces taxable income and tax withholding, so take-home pay will be reduced by less than $1. C’mon, you get my point!
Step 4: Get that contribution change processed!
Step 5: Draw $2k out of your side savings account every 2 weeks, because your paychecks are going to be weirdly small for the rest of the year. You live off that extra pile of cash in the meantime.
This approach can be used in any situation where you have a one-time chunk of money you’d like to contribute to your 401k, like an unexpected tax refund, a cash gift, or a one-off bonus or sales commission. Weirdly small paychecks can be an solid element of astute tax planning!
-Stephanie
Frequently Taxed Questions 