Let’s say you’re walking down the street and see a couple of hundred dollar bills blowing down the sidewalk. Would you pick them up? What if it was a thousand dollars? It seems obvious to take money that’s up for grabs. Unfortunately, the average employee is leaving $1,336 of “free money” on the table each year.1 How? By not saving enough in their 401(k) to get the full employer match. A 401(k) with employer match is a valuable employee benefit. But how does it work exactly?
Let’s start with why a 401(k) itself is so valuable. It offers some key advantages:
- Tax benefits. Tax advantages of a traditional pre-tax 401(k) work two ways. First, the amount you contribute isn’t taxed when you put it into the plan. This reduces your taxable income, and therefore the amount of taxes you pay in the present. Second, your contribution also gets to grow on a tax-deferred basis in the meantime.
- Compound growth. Compounding is what helps your money grow over time. As your money grows and your earnings then get reinvested in your account, you have a bigger pool of money that can make earnings going forward. So basically, your earnings are making earnings.
- Let’s assume that your 401(k) averages 8% a year in earnings and you have $1,000 in your account in year one. You’ll start off year two with $1,080, which in turn grows by 8%. This puts you at $1,166 to start year three. This rate of growth would continue each year as long as earnings stay steady.
The matching contribution.
A matching contribution is what it sounds like: It’s when your employer matches your own 401(k) contributions with company money. If your employer offers a match, they’ll typically match up to a certain percent of the amount you put in.
Let’s say that your employer matches your contributions to the plan, dollar for dollar, up to 3% of your salary. If you contribute 2% of your salary to your plan, your total 401(k) contribution will be 4% of your salary each month after the employer match is added. If you bump up your contribution by just 1% (so you’re putting in 3% of your salary), your total contribution is now 6% with the employer match.
If that sounds like a good deal, that’s because it is. The employer match is one of the main reasons a 401(k) is valuable for employees. Where else can you get an immediate return on your investment?
Unfortunately, many workers don’t take full advantage of the employer match because they’re not putting in enough themselves.
The picture to the right shows how an employer match could help fill out your annual retirement savings.
Why it matters.
A recent survey noted that “for three-quarters of employers, a defined contribution plan (like a 401(k)) is the primary source of retirement income for their employees.”2 How much you save, the match you get, and the performance of your investment choices can have a huge impact on what that life in retirement will look like. So don’t miss the low-hanging fruit that is the employer match — put enough of your paycheck into your 401(k) each month to get the maximum contribution from the company you work for. Your future retired self will thank you.