If Your Company Is Matching 401(k)s, Max It Out!
You've probably heard this from your folks when you were growing up: If you would just do what I tell you to do, I wouldn't have to tell you the same thing over and over.
In the world of retirement planning, that's what financial advisors are telling their clients when it comes to their 401(k) plans (or 403(b), if they work for a non-profit). If your employer wants to give you free money, you should definitely take it. So why do so many people say no?What's the Catch?
Maybe it seems too good to be true. Does it seem like something that must have a catch – like those Earn $10,000 per month working from home! ads that you see? There's no trick. Your employer is basically giving you money, gratis, by contributing to your 401(k). Just like health insurance, it's part of your employment benefits package.
Well, it is tricky, in a way: Matching some percentage of the funds you put into your 401(k) probably costs your employer a lot less than the old-school pension plans, to which you didn't have to contribute at all. Your company is no longer funding your whole retirement. They're offering to fund part of it; it's a relative deal for them.It's Probably Not That Much, Anyway
Oh, but it is! Let's say you make $50,000 per year. Your employer matches 50 cents for every dollar you contribute to your plan, up to 6% of your salary. If you made the maximum annual contribution that was eligible for an employee match ($3,000), your employer would give you an extra $1,500 per year. Over time that $1,500, added to your continued contributions and employer matches, becomes a substantial boost to your 401(k)'s growth.
That's not taking into account salary raises, rises in interest rates, stock market gains and other variables that could drive it even higher. For ideas on making that happen, See The Best Strategies to Maximize Your 401(k).I'm on a Budget
Possibly the largest objection from people regarding their 401(k)s is this: I would love to contribute more, but I don't have enough money. Nearly everybody, regardless of income level, has areas where they could cut expenses. Could you cut back on the features of your cell phone or cable plan? Order fewer espressos from the corner coffee house? Small changes can make a big difference. The earning power of that $4 that you spent at Starbucks is huge over time. What if we told you that investing that $4 would result in more than $200 over 25 years, assuming a 5% annual interest rate?What About the Tax Bite?
Great news: Your employee match is considered pretax income. That means you won't pay a dime of taxes on it. It's true that you will pay taxes on the funds, and any investment gains that have accrued from them, but that doesn't happen until you start taking distributions from the account or cash it out completely. And not even then, if you roll it over into a traditional IRA. (For more tips, see How to Minimize Taxes on 401(k) Withdrawals.)The Bottom Line
Many of the money decisions you have to make in your lifetime aren't cut and dried. You have to weigh a number of options and most people will tell you to talk to a financial professional. This isn't one of them. It's a no-brainer. Fund your 401(k) to the degree that will get you the entire company match. If your household expenses are too much to contribute the maximum, look for ways to reduce them.
It really is that important, to fund your plan as much as you can. In fact, in 2015, you can put up to $18,000 into your 401(k), plus an additional $6,000 if you're age 50 or over. If you're flush enough to do this (even if it's more than 6% of what you earn), that's even better Once you start seeing that retirement account grow, you'll soon be asking: Why are 401(k) contributions limited?