Whenever we get close to the end of the year, it is always important to take a step back and see if there are any last-minute chances to optimize one’s financial standing.
With many just beginning their jobs, the 401(k) comes to mind. When someone is a W2 employee, they generally only have the calendar year to contribute the maximum. There is generally no grace period, and unlike IRAs or HSAs, contributions for the prior year CANNOT be made up until mid-April of the following year.
Thus, a planning opportunity arises. I have discussed this topic in previous pieces. Depending on someone’s financial standing, nothing is stopping someone from adjusting contributions to a 401(k) to an egregious amount in hopes of reaching the maximum for 2025, which is $23,500 for nearly everyone reading this newsletter.
I refer to this as a rotation, and usually this strategy is only feasible when an individual is holding excess cash.
Essentially, all this is about is increasing 401(k) contributions for a current or future tax benefit (pre-tax or Roth), while using cash to assist with monthly expenses. Outside of a potential tax benefit, it is getting more money invested for the long-term!
Here is a hypothetical example of this:
Person A earns $120,000 annually. They currently hold $20,000 in excess cash. At the beginning of the year, they decided that contributing 10% of their income to their 401(k) would be reasonable.
Now, assuming we are a full 9 months into the year, they would have contributed $9,000. Which means that they have room to contribute an additional $14,500 in 2025.
However, they only have $30,000 in total compensation to be paid for 2025. Adjusting the contribution rate from 10% to a whopping 48% would allow them to reach the maximum for 2025.
But Cliff, $14,500 over 3 months is an insane amount of money! You are correct! BUT in this example, the individual had $20,000 in excess cash. Note: This is above and beyond the emergency fund or cash reserve.
Rather than letting that cash sit idle, the individual would use this cash to supplement their lifestyle expenses, given the significant decrease in net pay for increasing their deferral rate.
This is the “rotation” I was talking about earlier. For W2 workers, employee contributions MUST come from payroll. There is no ability to move cash from savings into an employer’s 401(k) plan.
Thus, the individual rotates from living on paychecks to living on excess cash, while deferring a significant portion of their paycheck to the 401(k).
Again, this is an aggressive savings strategy, and the stars have to align. Without the excess cash to supplement their lifestyle, someone could find themselves significantly crunched on a month-to-month basis.
Please note: The choice between Roth and pre-tax contributions will vary depending on someone’s total compensation. This is for another time and is definitely an item that planners are concerned with. The outline above is solely for the purpose of illustrating the idea of rotating cash to a qualified employer plan.
Here are some additional planning items that I would check in on as we approach year-end:
HSA contributions: Is an individual enrolled in a HDHP (high-deductible health plan) and not taking advantage of their HSA?!
Roth conversions: Was this year a lower-income year?
In other words -> did you JUST begin a job that pays $250,000 annually? That means that in 3 months, gross earnings for ‘25 will really be closer to $62,500. This would be significantly lower than future annual earnings.
Old IRAs and old pre-tax 401(k)s are eligible to be converted to a Roth IRA. Doing so when income is suppressed relative to future earnings can offer some serious tax arbitrage!
Cash reserve: Does an individual have enough cash to sustain 3-12 months’ worth of expenses?
High-interest debt: Is high-interest credit card debt accumulating? Time to get that spending in check and pay down that liability!
Here are some additional personal items that I would check in on as we approach year-end:
Are my savings in line with where I wanted them? Heading into Q4 can be a great time to double-check on progress towards financial goals.
Should I be paying more attention to my monthly spending?
Do I have any new financial goals before the year is up?
Are there areas of personal finance that I am guessing at?
This is for informational purposes only and is not intended as legal or investment advice or a recommendation of any particular security or strategy. The investment strategy and themes discussed herein may be unsuitable for investors depending on their specific investment objectives and financial situation. Opinions expressed in this commentary reflect subjective judgments of the author based on conditions at the time of publication and are subject to change without notice. Past performance is not indicative of future results.