Many individuals are offered an employer-sponsored savings plan though work such as a 401(k) or 403(b). Employers who offer these plans may provide a company match. This means that the employer will add money to the employee’s account, if the employee saves a certain percentage of income. Some employers will even provide money even if the employee is not saving.
If you’re employer offers a match on your contributions, take full advantage of it. Don’t leave money on the table! This is free money – and it’s unwise to not take it.
Let’s look at an example.
Sam and Betty (both age 45) have a 401(k) and their employer offers a 50% match on employee contributions up to 5% of their salary. They both earn $80,000 annually. Sam decides to save 1% of his salary and Betty decides to save the maximum she can for 2019 of $19,000. Since the match is 5% of their salary, they both qualify for a maximum employer match of $2,000 (50% of 5% of $80,000).
Sam’s contribution is $800, and his employer matches $400 for a total annual savings of $1,200. Betty’s contribution is $19,000, and her employer match is $2,000 for a total of $21,000. Sam has left $1,600 on the table. However, he’s leaving a lot more than that over time.
Assume that Sam and better will work another 20 years to age 65. Let’s also assume they invest in the same assets mix – a portfolio of 60% stocks and 40% bonds. Let’s also assume a return of 5% over 20 years.
In 20 years, Sam has a sum of $39,679. Betty has nearly eighteen times Sam’s amount at $694,385. Granted, Betty saved more – she’s smart. But what if Sam would have at least contributed to get the full employer match?
By saving 5% of his salary, Sam would have contributed $4,000, thereby qualifying him for the full employer match of $2,000 – saving a total of $6,000 annually. Over 20 years at 5% compounded Sam would have had $198,395. This is over $158,000 more than if Sam only saves 1% of his salary.
He left money on the table. A lot. We also assumed no raises, bonuses, etc. that would add to these amounts.
If you’re saving to a Roth 401(k) or 403(b), the match from your employer will be added to a pre-tax account. As you may know, contributions to Roth accounts are made with after-tax money, and qualified withdrawals are tax-free. Employer matches made with pre-tax money will be taxed when withdrawn at your ordinary income tax rate.
This shouldn’t discourage you from taking the full match. It’s still free money. Think of it this way. Would you rather be taxed on zero money, or a pre-tax amount given to you for free from your employer – allowed to grow and compound over time?
And, the employer match is added on top of employee contributions. Recall Betty’s scenario. Betty is maximizing her employee contributions this year at $19,000. Employer contributions are added to this amount. It’s possible to save even more than the employee maximums each year if you have an employer match.
Finally, many employers have strings attached to their matches via vesting schedules. This means that for the match to be completely yours, you must work for your employer for a certain length of time. Common vesting schedules include 2 to 6-year graded vesting (where a portion of the match becomes yours over the 2 to 6-year time frame), or 3-year cliff vesting where all the match becomes yours after three years of employment.
Your employer match is free money. Don’t leave any on the table.
Sterling Raskie, MSFS, CFP®, ChFC®
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I’ll never forget a conversation I had with one of my coworkers, we were both chemical engineers and both rose to high paying corporate positions over time. So there is no question he was a very smart guy, smart enough to earn millions in his career. But in our early days working together I asked him about his participation in the company savings plan. This was before 401K’s were a thing, but the plan let you invest up to 12% of your gross pay pre-tax and the company would match it at 50%. So you could put in twelve and the company would add in six percent more for free. I was telling him what a great deal that was. And unlike today’s plans there was no penalty for withdrawing it before retirement age so it was even better than a 401K. He said, yeah, but he could not afford to participate right then. This guy was single, and we both were making great money for young people. I could not believe he could not afford free money! He did drive a cool turbo sports car, but that thing is rusting in a junkyard now for sure, and my 401K has over a million dollars in it. I wonder sometimes what shape his finances are in now with the mindset he had, I hope he wised up over time.