Salary Deferrals: Dollar or Percent?

For my niece’s 7th birthday, my husband told me that he’d take care of the birthday money, proudly showing me a $50 bill.  She opened up her presents and cards from various family members and then got to ours.  Saying nothing, she stands up on the kitchen table, holds the bill to the light, smiles and then thanks us profusely.  This was her first time with a fifty dollar bill, so I guess she needed to verify its authenticity.  And, it’s also the first time that Aunt Missy was that generous so she was probably skeptical.  (Rightly so)!  What difference did it make to receive a fifty dollar bill versus two twenties and a ten?  Not much, but it provides our family a story that we’re still amused by.

Likewise, your retirement plan may permit you to defer a set dollar or set percentage.  What difference does it make if you’re contributing $100 a pay or 10% of your $1,000 paycheck?*  It might not seem to be different, but sometimes it can make a difference.  Review these tips below to make sure you’re contributing in the best manner for you.

*Illustration purposes only.

Are you an hourly employee?  Consider a percentage.

By contributing a percentage, your contributions to your retirement account may fluctuate based on your paycheck.  Employees eligible for overtime pay may be able to contribute a bit more to their retirement for those pay periods.  But also take into consideration if your pay is less than normal for less hours worked than anticipated.  I had a plan with participants that were part of a highway repair crew – if it rained, they didn’t go to work or get paid for that day.  So let’s use our $100 a pay or 10% of your $1,000 paycheck sample again.  If an hourly employee is contributing 10% each pay and their gross pay is $800 for that pay period, $80 goes to their retirement plan – their contribution and paycheck are both less.  If an hourly employee is contributing a flat $100 a pay and their gross pay is $800 for that pay period, their contribution remains the same, but now their take home pay may be significantly impacted.  This might work for some, but for others that are balancing a tight budget, this uncertainty may be unwelcome.

Are you planning to max out your retirement account?  Consider a dollar amount.

Participants that choose to max out their accounts might prefer a dollar deferral to get to the full contribution limit.  For 2019, the IRS contribution limit is $19,000, so if a participant gets paid bi-weekly, they might decide to defer $730.77 each pay to get to the limit.  A dollar contribution might be an easier way to get to the contribution limit than determining the percentage of pay.

Note:  If you’re 50 or over, you may also be eligible for up to $6,000 in catch up contributions this year.

Do you regularly receive raises?  Consider a percentage.

If you receive a pay raise annually, contributing a percentage means that you end up contributing a little bit more as well.  And you didn’t need to do anything to make that change!  Nice and easy!

Does your company offer a match?  Do your math.

I was talking to a participant one time that was contributing a flat dollar amount and was quite comfortable with the situation.  Our discussion continued and she brought out a pay stub.  When we calculated the dollar amount and the match based on her pay, we discovered that she was $2 short of receiving her full employer match.  Fortunately, $2 isn’t a huge amount of money lost from the match, nor was it a significant change to her deferral amount, so we were able to update it immediately.  If you think you may be in a similar situation, be sure to run the numbers periodically to ensure that it works.  You may want to switch to a percentage just to ensure your getting the full match.  Or, if your pay is fairly consistent such as the person I was speaking to, you may want to add a few extra dollars to your deferral to make sure you’re not shorting yourself.

While sample scenarios were provided for illustrative purposes, every situation is different and there’s no one answer that works best for everyone.  Contribute what you are comfortable with and make it a point to review (and hopefully, increase!) your deferral periodically.  Depending on your plan design, deferral changes may be permitted online or through a contribution change form.

Melissa Varvarezeis, CFP™, is a Communication and Education Specialist with BPAS Fiduciary Services.