First of all, congratulations! If you’ve just started a new job that offers a 401(k)-matching program, you’ve taken a big step on your journey to building wealth and likely a move in the right direction for your career too! You’re probably pretty keen on how your new job helps your career but the 401(k) aspects may seem a bit more hazy – not to worry! We’ll cover what this means and why it is important to your financial future.
A 401(k) is an investment vehicle with meant to help employees save for retirement (and it’s tax-deferred, so the more you contribute, the less you’ll pay in taxes this year – instead you’ll pay taxes when you withdraw the money in retirement). As employers and the economy at large shift away from pension plans, 401(k)s have exponentially grown in popularity. While there may be a few disadvantages (keep in mind, there are disadvantages to everything if you look hard enough), 401(k)s are widely accepted as a win for the individual controlling their own 40retirement fate.
Put simply, you yourself can elect to have your employer automatically deduct a percentage of your pay checks and invest in the 401(k). For instance, you might tell your employer to put 10% of your gross income from each and every one of your paychecks into the 401(k) plan.
Pay Close Attention To Matches Offered
As an investment into their employees’ futures and as a part of their total benefit package, many companies will match a percentage of an individual’s contribution to their 401(k) plan. Here’s an example:
Penny works for 321 Ventures and earns a $50,000 salary each year. She chooses to contribute 10% of her pre-tax income to the 401(k) plan.
Her employer’s rules state that they will match 50% of her contributions with a maximum employer contribution of $4,000 per year. This is the employer’s safety net. Because they don’t want to spend too much, the place a cap on matches. Most employers do this.
In Penny’s example, she will contribute $5,000 of her own money. Her employer will contribute 50% of her contribution, so $2,500. At the end of the year, her 401(k) balance will be $7,500 (pending gains or losses from the investments within her portfolio).
Let’s look at Marshall now, who has the same position as Penny at 321 Ventures and earns the same $50,000 salary. However, Marshall instead contributes 20% of his income to the 401(k) plan. Way to go Marshall!
Marshall’s investment will be $10,000 of his money plus the maximum employer match of $4,000. Marshall saved $14,000 this year to his plan! Because 50% of Marshall’s investment is over the $4,000 employer cap, the employer match will be the $4,000.
Every Employer Sets Its Own Rules
Please note that each employer sets their own thresholds. The example above of 50% with a $5,000 cap is a common set-up, though your employer may have different rules. Consult your company’s HR department or carefully read your employment contract if you are unsure of the employer match being offered for your job.
401(k) employer matches are so great because it is basically free money. It is a benefit that is technically a factor in your total employment package, but nonetheless it is money that you otherwise wouldn’t have. If it is possible for your personal financial situation, the best decision is always to contribute enough to at least get the employer cap. Otherwise, it is money left on the table.