A Match Made in Heaven
All too often I talk with clients who have the opportunity to participate in their company-sponsored 401(k) and simply don’t.
“Even when there’s a match?” I ask.
“I can’t afford it,” they claim.
“You can’t afford not to,” I retaliate.
When a company offers a plan that allows you to contribute to your retirement in a tax-deductible manner (withdrawals are often taxable), it behooves you to take advantage, especially when they offer a matching program.
Don’t pass on the free cash!
You see, there are two distinct reasons for one to contribute to a 401(k) at work. The first is the contribution limit; the second, a company match. In 2007, eligible participants under the age of 50 are allowed to defer and deduct up to $15,000 of their income, not including any employer-matching funds. If you are over the age of 50, you may qualify for what’s called the “catch-up provision.” This allows eligible participants who have reached the half-century mark to accelerate their contributions by another $5,000 per year for a total of $20,000 or 100% of your earned income from that company, whichever is less. Who says there aren’t advantages to getting older?
But the significant advantage is the match, should your company offer it. If they don’t, ask them why. As you place monies in your retirement account at work, the employer can benefit by matching the contributions you and your fellow co-workers’ make to retirement accounts. This often results in more tax deductions and lower turnover for the employer, meanwhile you get more free money.
Here’s how the match breaks down.
If you were to put $100,000 into a savings account, the bank may offer 3% (remember inflation averages almost 5% over the past 50 years, according to the Consumer Price Index). Should you put those monies into a professionally managed mutual fund spread over multiple asset classes, (which is offered through most company-sponsored 401k plans), the average over the past 50 years was almost 12%. While there are no guarantees in the market, if you consider inflation, you are almost guaranteed to lose at the bank. Furthermore, with an employer match, let’s just say they offer 50-cents-on-the-dollar for every dollar you contribute (typically up to a certain percentage, say 6%), you are now getting a 50% rate of return even before it hits the market. Sometimes employers offer 25% match, sometimes 75%, sometimes 100%. Whichever the offering, this is free money many are walking away from. Guaranteed money.
Bank — 3%
Stock/Bond Market — 12% (no guarantees)
Employer Match — 50% (depending on the match)
When you throw in the part where the government chips in (your deduction), you are looking at the possibility of pitching in to an account that others have contributed the majority to. All of this just to encourage you to plan for yourself.
How much more do you need to get started?
There’s another interesting twist for those of us who work for employers that provide domestic partner benefits like health insurance.
The value of the benefits your company provides to your partner are considered “imputed income” to you, for tax purposes. Mostly this sucks.
HOWEVER, when it comes to your 401k, it is actually a benefit! Instead of getting that match on your real salary, you get the match on your salary + imputed income.
Here’s how the math works:
Let’s say your salary was $1000 per week and you were saving 15% in your 401k. With a 50% match up to 6%, your employer would be giving you $30/week.
If your domestic partner benefits cost another $100 per week, your “income” would be $1100 per week. That 50% match up to 6% means your employer would now be giving you $33/week, or an additional $156/year.
Also, if you stayed saving the same 15% yourself, instead of putting away $150/week, you would be putting away $165/week, or $780/year. Your contributions are also based on the percentage of your income including imputed income.
Where this really makes a difference is if your employer limits you to a specific percentage contribution, not just the dollar max imposed by the IRS. In my company, for example, no one can contribute more than 15%.
It isn’t a lot of extra free money, but it makes me feel marginally better about the unfair tax treatment.