Personal Finance: Ask the Experts: Should I use overtime paychecks for my 401(k) contribution?

Personal Finance: Ask the Experts

Get advice on money matters from The Bee's Claudia Buck and a panel of local experts

March 1, 2013

Should I use overtime paychecks for my 401(k) contribution?

Q: Would it be better tax-wise to use overtime cash payments (I think overtime payments are taxed much higher) at the end of the year to pay for my full year 401(k) contributions, rather than money from my paycheck?

Jose
Sacramento, CA

A. With respect to your ultimate tax liability, it does not matter if you fund your 401(k) contribution from your regular paychecks or from overtime or bonus checks. Assuming the same amount is deferred into your regular 401(k) account, your taxable compensation will be the same. However, when you fund your 401(k) contribution will affect your income tax withholding.

If your regular paychecks are less than your year-end overtime check, less income tax withholding is normally taken out. Deferring money from your regular paychecks into your 401(k) account may reduce your income tax withholding less, since less is being withheld. Deferring more of your overtime check into your 401(k) account may result in a greater reduction of your income tax withholding, since the larger check will have larger amounts withheld. At the end of the year, your tax liability will be the same, but your withheld taxes may be different, resulting in a smaller refund (or larger balance due).

There is one other consideration, aside from the income tax withholding: the amount of income your 401(k) account will earn. The money put into the account starts to earn income as soon as it is deposited. Waiting until the end of the year to fund the contribution means the money won't start earning income until the end of the year. So it is usually better to start your 401(k) contributions as early in the year as possible so that the money is earning tax-deferred income for a longer period of time.

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Claudia Buck is The Sacramento Bee's personal finance columnist. Read all her columns here. Contact her at cbuck@sacbee.com

Terri Carpenter

Terri Carpenter offers advice on job hunting, retraining and career counseling. Carpenter works at Sacramento Works Inc., the career and job training arm of the Sacramento Employment and Training Agency (SETA). With 15 years in the field, she has hands-on experience with everyone from first-time job seekers to career professionals seeking advice after a layoff or looking for a mid-career change. Ask her a question.

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