I’m loving all things free right now. We’ve been getting a lot of free things lately. We got a free washer from a neighbor, a free treadmill and weight bench in hopes of getting rid of the gym membership that we don’t use, dozens of free chicken and duck eggs (literally dozens). Who doesn’t love free stuff?
Let’s talk about something else that you can get for free. Money. No joke. Money.
If your employer has a 401k matching program, then you can get money for free. Sure you can look at it a few different ways: an increase in salary, an increase in incentives, free money. Any way you look at it, you get extra cash for doing something very simple.
When it comes to saving for retirement, there is one simple rule that everyone should follow at a minimum. Contribute enough into your 401k to get your employer matching contribution. Don’t be that person that says no to free money. Just don’t.
What is a 401K?
A 401K is actually an IRS tax code designating rules for employer sponsored retirement accounts. You, as the employee, can choose to automatically put a certain percentage of your salary into this account, up to $19,000 (as of 2019).
Typically, you will need to opt into this kind of account. Your boss or a human resources person can help you with this if you didn’t opt in when you started your job.
The cash that is in a 401k is tax-deferred money that is supposed to be saved, invested, and then used when you are “properly” retired – as in over 59 ½ years old according to the IRS. Money that goes into your 401k is not taxed when your get your paycheck but when you withdraw it from your 401k. The power of tax deferment cannot be overstated.
If you pull the money out of the account before you hit the big five-nine-and-a-half, the IRS will slap you with a 10% penalty on top of regular taxes, which is the incentive to save the money for when you are older.
There are a few other idiosyncrasies with 401ks that we can get into later. But for now, let’s talk about the match.
The Employer 401k Match
Some, sadly not all, companies offer a 401k match as an incentive to working for them. Simply put, a company will deposit money into your 401k, up to a certain percentage matching the money that you put in from your salary. This makes deciding on your minimum contribution very easy (hint, it’s not $0.)
For Example: Say you work for a company that offers a 3% match. The minimum that you should contribute from your salary into your account is 3%. Absolute minimum.
Now let’s say your annual salary is $40,000. Your 3% contribution would equal $1,200 over the course of the year. But your company is also contributing $1,200 because it matches 3%. So instead of having an ending balance of $1,200, you now have $2,400.
That’s an instant 100% return on your money. Guaranteed. Very few investments are this good. Very few. Maybe buying toothpaste during a two for one sale. Or finding a twenty dollar bill on the sidewalk.
So, the way I see it, you have a few options.
I know some of you probably don’t worry too much about retirement. Why would you when you have bills to pay and possibly mouths to feed. So let’s do some quick math (it’ll be easy math, I promise).
First, there is the perfectly reasonable argument that, given the example above, you are only taking $100 out of your monthly pay. If you get paid twice a month, that’s only $50 out of every paycheck. You’d be surprised how quickly you will adjust to a paycheck that is $50 less.
But let’s have some fun and say that you are so anti-saving-for-retirement that you opt out of your company’s 401k altogether. (Don’t actually do this, this is for example purposes only.)
Option A: You just don’t contribute and you keep your $50 per paycheck (or $1,200 annually).
Option B: Instead of just taking that $50 per paycheck and putting it into your bank account to spend all willy-nilly, you could take a look into your 401k plan documents. Maybe your plan lets you take money out of the account whenever you’d like. Not a lot of plans allow this, but some do.
Now, you’re kinda financially savvy, so you decide to contribute to your 401k to get that 3% match from your company. So…
You put in $50 pre-tax from your paycheck. Your company matches your $50. You take the money out.
Now before you get excited because you think you just doubled your money, we have to remember that pesky 10% penalty. That $100 just became $90 ($10 goes to the IRS for the penalty).
And since you haven’t paid any taxes on the money yet, you would get to do that now. Thanks Uncle Sam.
Option C: Now say you are actually financially savvy. You decide that you want to take advantage of your 401k account and save some money with it. You put in your 3%, your employer matches that 3%. And you now invest the balance into some index fund that gives a conservative return.
Let’s take a look at all three options, side by side.
In our example, if you decide to simply go for your employer’s 401k match with the intent to withdraw the money immediately, you pocket $720 more than if you just took the cash in your paycheck. Sounds pretty good right? Free money! But remember, most 401k plans aren’t going to let you take money out whenever you feel like it. Option B probably isn’t an actual option for most people.
But let’s take a look at Option C. Instead of $720 extra dollars, wouldn’t you rather have $1,560? Though not in your “pocket” it is now part of your total wealth.
What if you worked at this job for 20 years?
(Quick disclaimer: I’ve used simplified math for these examples just for the sake of my sanity. We’re assuming that you don’t get any raises or bonuses, that the 5% return happens every year, and that you don’t increase or decrease your retirement savings.)
Option C gives you almost $80k in your 401k account. That’s way better than $33k in your pocket. Don’t believe me? Let me show you…
Let’s assume that you had a huge lapse in judgment and decided to take your $79,662 out to spend it on something all willy-nilly-like. You’re still not 59 ½, so you still have to pay the 10% penalty (The IRS will appreciate your $8,000 donation and I am sure our government will spend it wisely….). We will still assume a flat 20% tax rate.
That’s over $20,000 extra dollars. Even more free money!
Be the Financially-Savvy Person
Don’t be the person who is set on the idea that they can’t live without that 3% or 5% of their salary. Over time, you are giving up so much more than that extra match that you get from your employer. You’re giving up compounding interest. That’s the best kind of interest!
Let me tell you, you can live with a little less in your paycheck. Maybe don’t buy those new shoes. Maybe sacrifice a night out with dinner at home followed by a free event put on by your city. Cut back on your discretionary spending a bit and eventually you won’t even miss the couple hundred dollars you’re saving.
If you truly can’t make ends meet with 5% less in your paycheck, then that’s a problem. You need to reassess your career. Start thinking about looking for a new job that pays more. Or if you really like your company, talk to your boss about what you can do to advance your career (into higher pay).
If you’re an intern or somehow getting paid pittance now in order to get a great position in the future, then you’re probably not going to be offered a 401k match in the first place. But that great position you’re working toward will probably come with one, along with some other awesome benefits. Take advantage of them when you get that there!
Other Retirement Options
There are some careers that just aren’t going to come with retirement plans. That’s OK. There are other options to save for retirement: traditional or early. Let me know down below if you want any info on these.
Never Pass Up Free Money
To sum up, contributing enough to your 401k to get your employer’s contribution match is just plain smart. No matter what the percent. The money comes out of your paycheck automatically, so eventually you’ll forget that it’s missing altogether. The money is still yours, and the money your employer puts in becomes yours too. It’s a perfect way to start saving and investing for your future.
If you have any questions about a 401k or any other kind of retirement account, or if you want to let us all know about your own personal experience with this awesome incentive, leave a comment below.