Take Advantage of 401(k) Matching

We're all encouraged to put money away for retirement. With traditional pensions on the decline and Social Security raising concerns, it's more important than ever to take advantage of every opportunity afforded us. A key component of anyone's retirement strategy should be an employer 401(k) plan. The benefits of "paying yourself first" using pre-tax contributions and compound interest have been well documented.

Despite this, as many as 30% of Americans aren't participating at all in their company 401(k) plans--a figure that balloons to 54% for workers under 30 (Source: Hewitt Associates). Even among those who do participate, contributions often fall short of what is necessary to ensure a satisfactory replacement income upon retirement. The money you set aside today will be the difference between living and living well as a retiree.

One key incentive that's been offered for years is the employer matching contribution. The company agrees to match 50 cents of each dollar the employee contributes up to a maximum amount, usually 6% of salary. Whether you view it as "free money" or earned wages, missing out on the full employer contribution is a mistake in the long run. Yet studies have continued to show that many workers are giving up hundreds of dollars each year by failing to max out their employer match.

How much can it hurt? Let's examine the effect on two workers over the course of only ten years.

Employer Matching Contributions: A Comparison

Both of our fictitious employees are making the same amount ($40,000) and starting their accounts with a zero balance. Their company offers a match of 50 cents on the dollar up to 6% of salary (a maximum of $2,400). Bob isn't maxing out his contribution, while Linda gets the full match.

Bob. Contributing regularly to his 401(k), Bob is putting away $250 a month, and his employer matches half of that for $125 per month. That $375 gives Bob $4,500 in annual contributions. At an average investment rate of 8%, his account grows as follows:

Year 1: $4,699.85
Year 5: $27,737.51
Year 10: $69,062.13

While that's an improvement over the $46,041.42 he'd have without the match at all, Bob is going to be unpleasantly surprised if he and Linda ever compare their respective balance sheets.

Linda. Meanwhile, Linda has been contributing to the maximum amount matched by the company. That's $400 every month, with the company kicking in an additional $200, totaling $600 each month, or $7,200 annually. At the same 8% rate, Linda's account balance looks significantly better:

Year 1: $7,519.76
Year 5: $44,380.02
Year 10: $110,499.41

After a decade, Linda is ahead of Bob to the tune of $41,437.28. Accounting for bonuses, raises, and promotions over that time, those figures will be even more disparate. As if that weren't benefit enough, Linda has also dropped her Adjusted Gross Income from $40,000 to $35,200, providing her with some tax relief as well.

Like it or not, corporate America has passed on the burden of funding retirement increasingly on the employee. The matching contribution is an important incentive to plan participation, and it's one of the few remaining retirement costs that companies seem willing to bear. The above examples should demonstrate the detrimental effect over a relatively short timeframe in leaving that money behind. Take the advantage when it's there for you to prepare for a happy retirement.

Sources

Gross, Daniel. "911 for 401(k)s." Slate Magazine. http://slate.com/id/2114196/

Linton, Clifton. "How Much Is Your Employer-matching Contribution Really Worth?" 401khelpcenter.com. http://www.401khelpcenter.com/mpower/feature_100200.html

Money Magazine. "Money 101, Lesson 23: 401(k)s." http://money.cnn.com/magazines/moneymag/money101/lesson23/

Orman, Suze. "Your 401(k) match from your boss is free money." Ventura County-Star. http://www.venturacountystar.com/news/2007/aug/26/

your-401k-match-from-your-boss-is-free-money/