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LIVING IN THE PACIFIC Northwest, my favorite time of year is summer. I love the extra daylight and relief from the nagging rain. In recent years, there’s been an additional reason to look forward to summer: I get to see my paycheck again.
Some background: A few years ago, in an online investment forum, another participant—I’ll call him Dave—gave me a tip for early retirement. He suggested that I practice living off my investment portfolio even while working. Many early retirees, in Dave’s opinion, spend too little in the initial years because they struggle with depleting their savings.
I decided to give it a try. As a first step, I maxed out my payroll 401(k) contribution. The leftover money in each paycheck went to the employee stock purchase plan and additional tax withholding. These various payroll deductions exhausted my entire part-time pay. That meant I had to cover all my expenses with my investment accounts.
As Dave suspected, I’ve had a hard time spending from my brokerage account, especially if it involved selling investments. I figured that a monthly cash distribution would work better psychologically. This prompted me to look for more income-generating investments, such as closed-end bond, utility and real estate funds. Their monthly distributions cover my groceries and utilities. For most of my other funds, the first-quarter distributions arrive in April, just in time to take care of the property tax payments. I tend to defer big-ticket expenses until later months when I start seeing my paycheck again.
Recently, extra cash showed up in my bank account on payday. It’s a sign that that my total 401(k) contribution—pretax, catchup and after-tax investments—reached the maximum annual limit. The paycheck drought is over for another year.
Just a comment that may or may not apply to your specific situation – if there is an employer match with the 401k the annual match is maximized by a combination of contributing at least the minimum % to maximize the match in every payroll period and to do this over the full calendar year.
Bunching contributions eliminates or reduces the match in payroll periods with contributions lower than the maximum match rate and, of course, are zero during periods with no contributions.
Thanks, Ira. You spotted a very important issue that may apply to some 401(k) plans. Thankfully, for both me and my wife, the match is based on the contribution amount and hence this issue doesn’t apply for the 401(k). But it does (indirectly) apply to the ESPP contribution and one can fall short of the annual allowable limit if the initial ESPP deductions are missed (due to too much tax withholding or 401K front-loading).
My last employer before I retired didn’t match catch-up contributions, so I ended up doing a front- and rear-load, with minimum contributions mid-year. This strategy resulted in missing the match only on the last paycheck of the year.
You raise an important point — but it depends on the employer. Some employers match pay period by pay period. Others give the full match even if you front load contributions. If you plan to use the latter approach, you should first check on your employer’s matching strategy.