When does it make sense to turn down free money?
The answer is fairly obvious. It never makes sense to pass up on free money (as long as there are truly no strings attached). But even though this is obvious, many people voluntarily pass up the opportunity to receive hundreds or even thousands of dollars every year through their employer’s 401(k) or other retirement savings plans. A study by Financial Engines found that American workers forfeit an estimated $24 billion per year by not taking full advantage of the company matches in their 401(k) plans.
A 401(k) plan is an effective tool you can use to prepare for a comfortable retirement — and a company match is can double the amount of money you tuck away for your golden years. On the other hand, if you’re not “maxing out” that benefit, you’re cutting your potential savings by as much as 50%.
Real World Application
Let’s say you’re:
- 30 years old
- Earning $40,000 a year
- Working at a job that matches your retirement contributions dollar-for-dollar up to 3% of your salary.
For the sake of simplicity, let’s say you keep the same job until you retire at 65… and your boss never gives you a raise. (Disrespect!). At 3%, your employer is willing to deposit up to $1,200 a year into your retirement account — as long as you’re willing to do the same thing. Over the next 35 years, you will have saved $42,000… and your company match will have chipped in another $42,000. That gives you a total of $84,000 in dollars saved.
As you probably know, your retirement account, whether it’s a 401(k), a 403(b), IRA, etc., doesn’t just put your money into a vault for safekeeping. It invests your savings. Again, for the sake of simplicity, let’s say you get a 10% annual return. You’d have about $760,000 in your account when you retire at 65.
What if you decided not to take full advantage of the employer match? Say you invested 2% of your income instead of 3%. All other factors being equal, you would have about $510,000 at age 65 — $250,000 less than if you’d maxed out the benefit.
That’s a whole lot of reasons to take advantage of that company match!
In addition to the extra money you’ll be enjoying when it’s time to retire, you could also get tax advantages right away. Your 401(k) or 403(b) contributions are pre-tax dollars. You don’t have to pay income tax on them until you withdraw them, which shouldn’t be until you retire. In this scenario, you only have to pay taxes on $38,800 instead of $40,000. (Employer-sponsored IRAs are funded with after-tax dollars.)
So, are you capitalizing on the full benefit of your employer match? If not, or if you’re not sure where you stand, here are a few action steps:
- Find out exactly what your company offers in this area. Not all companies will match your contributions, and the ones that do pay out according to different formulas.According to the most recent data, the most common match is 50 cents on the dollar; about 40% of companies contribute 50 cents for every dollar up to a maximum of 6% of the employee’s salary. Another 38% of companies match dollar-for-dollar up to 3% of the employee’s salary.You also have to look into the vesting schedule. In many plans, the employee only “owns” a percentage of the company match until a certain amount of time has passed. That ownership usually increases over time. According to the Bureau of Labor Statistics, it takes an average of 5 years to be 100% vested.It’s up to you to find out what your company offers. But you don’t have to do it alone. Your financial planner can help you sort through all the details.
- Take advantage of every dollar your employer is willing to contribute to your retirement if you’re able to do so. And start as early as possible.
Remember, it doesn’t make sense to pass up free money!
But keep in mind, you don’t have to limit your contributions to what your employer will match. In 2019, the IRS will allow you to put up to $19,000 into a 401(k) and $6,000 in an IRA without penalty. The more you can invest into your account, the more comfortable your retirement is likely to be.
- Get advice from a professional financial advisor. Advice from a professional can make all the difference in the world when it comes to getting the most “bang” for your retirement buck.
The financial advisors at Freeman Capital can help you understand your company retirement plan, maximize your total benefit, pick the right funds to invest in (which is another conversation entirely) and make wise choices in many other areas of your financial life.
Schedule a time to speak with one of our financial advisors today.
Freeman Capital Advisors is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.