January 7, 2011

Double Your Money

Most people are eligible for a 401k plan at work.    Most 401k plans offer some sort of employer match to your contribution.   That 410k employer match is FREE money from your employer.    Employer matches often match 100% of your contribution up to a fixed limit.   That employer match is effectively doubling your money.  You won't find another guaranteed 50-100% return out there so the 401k employer match should be your #1 priority for retirement savings.  Unfortunately far too many people don't contribute to their 401k plan and miss out on this free employer matching money.

401k Participation Rates 

Overall roughly 2/3 of people with 401k plans participate in the plan.  The exact participation rates vary and go up and down over the years.     USA Today reported:   "Overall participation rates in 401(k) plans fell from 65% in 2009 to 60% this year,"   The participation rate numbers are a bit higher for people with employer matches but still not nearly 100%.

I found an older study  How Workers Use 401k Plans but it mostly has data from the 1990's. 

The study says that "For all workers, participation rates are higher when there is an employer match, 67 percent versus 60 percent."   So that means that from their data they found that there were 33% of people who did not participate in their 401k plan even though there was an employer match.
 A survey from Schwab found a bit higher participation rates.   They say: "Plan participation increases to 76 percent of all eligible employees when a 401(k) match is offered compared to 70 percent when no employer contribution is available,"    From their figures the 76% participation rate would mean 24% of people with a 401k match don't contribute.   A Fidelity report says that they found in 2007 that "The average employee participation rate for companies that offer a match is 63 percent. At companies that do not offer a match it is 57 percent."   That would mean 37% of people don't take advantage of a match offered.    Thats three different sources citing figures of 63%, 67% and 76% for the participation rate with employer match plans.  This tells us that there are anywhere from 24% to 37% of people eligible for employer matching 401k funds who are NOT participating in the 401k plan at all.

Thats a lot of people who are losing out on a lot of money.   We're talking tens of billions of dollars lost across the country.   For an individual family the difference can be like a 3-5% pay raise.    Typical employer match rates are in the 3% range.  The exact nature of the match varies but according to Fidelity about 35% of plans offer 100% match on the first 3% and another 14% offer 50% match on the first 6%.  

About 20-30% of Americans are leaving +3% of free income on the table by not utilizing their 401k employer match.

"But I NEED the money"
I'm assuming that many if not most people who don't participate in their 401k are not contributing because they feel they need that money to live on and pay the bills.  I understand if you are struggling and living paycheck to paycheck that it can feel impossible to save money for retirement.    But missing out on 50-100% return on your money is simply throwing out money.     You need money right?   Do you know a better way to turn $100 into $150 or $200 instantly?   Unless you've got a magical investment secret nobody else knows about then you should jump at a chance to have your employer match your funds.    This is the best way to save for retirement.   You have to somehow find a way to put something into your 401k to get that matching free money.   Even if you start with a very small amount its a start.   $20 a month today could grow to $50  a month next year and $100 a month the year after that.   I know its sometimes easier said than done and sometimes people are in a real tight spot.  If thats honestly you you then you have to do what is right to put food on the table.   But for most of us we can find a way to squeeze a few bucks out of our budget by simply giving up some luxuries, being more frugal or otherwise tracking and controlling our spending.

Plus keep in mind that the money you put in your 401k will often help reduce your tax bill.   If you're a single person making $45,000 with a standard deduction then you're paying 25% on every additional dollar in taxes.    That means that if you put $100 into your 401k then its only $75 less out of your paycheck.   Of course if you're in a lower 10-15% tax bracket then the tax impact is less.   But in any case the bite you feel out of your paycheck is less due to the tax benefits.

Even if you have to cash out the 401k later and pay the 10% early penalty you'll still come out ahead if you get a 50-100% match. 

Here's an example of that: Lets say you make $20,000 and get a 100% match on the first 3% of your pay.   If you put 3% of your pay into your 401k then your employer with match it with another 3%.   3% of $20,000 would be $600 so your $600 will be matched with $600 from your employer to give you $1200 total.   Now lets say you pull that $1200 early cause you are unemployed for an extended period.  You'll have to pay a 10% penalty on the withdrawal.   10% penalty on $1200 is $120.   Initially you put in $600 and you get $1,080 out after the penalty.  I'm not figuring taxes but that would be a wash since you'll either have to pay them now or later.

Roth IRA's aren't better

People LOVE Roth IRA's.   Thats understandable.   The Roth IRA is a great retirement vehicle. However Roth IRA's do not guarantee you free money like a 401k employer match.    Would you rather have $100 in a Roth IRA or $150 or $200 in a 401k? 

Now you might think that taxes make the Roth IRA win.   It is feasible that taxes could make a Roth IRA better.  However that is a very unusual scenario that would be based on paying virtually no taxes today and a fairly high tax rate tomorrow.   You'd have to go from pauper in your working years to a prince in retirement.  If your tax rate is 0% today then its almost a given that you won't be in a very high tax bracket in your retirement years.  If you're the exception to that then send me an email, I'd love to hear your story.   For the other 99.99% of us the Roth IRA is not going to come out ahead even with wacky up side down tax implications.

Think of it this way:  We can't tell what the future will bring but I'd rather have $200 in retirement today than $100.  A bird in the hand is better than 2 in the bush.   $200 today versus $100 is kinda like 2 birds in the hand versus one in the bush. 2 birds in the hand should be 4 times better than 1 in the bush.    Ok so if thats getting to smartsy clever then how about I just end with this :

$200 > $100   

Bottom Line:  If you are eligible for a 401k employer match then you should contribute to your 401k up to the point of the match.  If you don't then you're losing out on free money.

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