The importance of your employer’s match of your retirement investing in their company sponsored 401k plan cannot be overstated. Many people worry about earning the highest possible investment return on their stocks, bonds, and mutual funds. They aim to earn 8%, or 10%, or 12% per year as they march toward retirement. Meanwhile they miss out on the largest boost your retirement could ever get: your employer’s match on your 401k.
No Excuse: Earn a 50% to 100% in Free Money
Instead of worrying about the investment return your retirement accounts will earn this year, you should focus on making sure you get absolutely free money from your employer. How employers provide a match to their employees retirement accounts varies, so check with your human resources department.
The most common matches fall under one of following:
A dollar for dollar match up to a certain percentage of your earnings.
Your employer might offer to match every dollar you put into your 401k up to a certain amount of your earnings. Since your 401k deduction is done on a percentage basis, your employer might match you dollar for dollar up to 6% of your income. That means if you put in 3%, they’ll match that 3%. If you put in the full 6%, they will match it. If you put in 10%, they’ll match 6%.
In this scenario you are essentially earning a 100% risk-free return on your investment. You put the money in during the plan year, and at the end of the year your employer deposits an amount equal to your contributions. The money invested into the plan just doubled, which comes out to a 100% “return”.
A 50% match up to a certain percentage of your earnings.
Some employers tone down the generosity and match 50% of your contributions up to a certain level of contribution. They might match you 50% on every contribution up to 6% of your income. If you put in 3% toward retirement, they give you an extra 1.5% (or 50% of what you contributed). While not as good as a 100% dollar for dollar match, a 50% bump in your retirement contributions that year isn’t half bad either.
A flat dollar amount if you invest a certain amount.
A third method of matching is by setting up goals for employees’ contributions. An employer might offer to match you dollar for dollar on the first $1,000 of the money you invest into the plan and then 50 cents on every dollar invested up to $5,000 after that. If you put in $5,000 to the plan, the company would match you $3,000 ($1,000 + 50% of $4,000).
Calculate the Impact of 401k on Your Retirement
We will use a theoretical scenario to best illustrate the impact of a 401k match. Let’s say you start working this year and earn $50,000 per year, contribute 6% to your retirement ($3,000), and generate a 8% return on your 401k on an annual basis. You work for 30 years in the same job before retiring, inflation is 0%, and you never make more or less than $50,000 per year. For the sake of simplicity we’ll say the full investment (and any match) goes in on the first day of the year all at once rather than throughout the year.
Without a match on your 401k, you would reach retirement with $402,640.
With a dollar for dollar match of your contribution on the same amount of investment, you would reach retirement with $805,281.
That’s a difference of $402,641 – essentially your balance if you had no match. To get to $805,281 without a match, your investment return would have to be over 11% consistently.
Check Your 401k Deduction Percentage
Your 401k match is one of the most important pieces to your retirement. It is important enough for many employers to automatically enroll you at 3% when you are first hired on with a new company. If you aren’t sure what your current 401k deduction (and needed amount to get a match) are, talk with HR today to make sure you are maximizing the free money the company is willing to give you.