The Biggest Mistake You Might Be Making With Your 401(k)

401k mistake

401(k)s are incredible tools for building future wealth. They have a lot going for them: tax advantaged accounts with tax-free (Roth) or tax-deferred options, well-diversified investments through mutual funds, and high total contribution limits.

But truly one of the most admirable benefits of a 401(k)--which many companies offer through their 401(k) plans--is the company match. This is absolutely free money to you, as long as you pitch in your share. However, recent research shows that not everyone takes advantage of the full match--or even participates in their 401(k) plan at all!

To help you understand the huge benefits of earning your full 401(k) match, here are some thoughts on how 401(k) matches work, a real-world illustration of how they can impact your wealth, and why you may not be getting all that’s being offered.

How Your 401(k) Match Works

Earning your company’s 401(k) match is pretty straightforward. Your company specifies an amount they will contribute to your 401(k) plan. As I mentioned, the catch is they require you to have some skin in the game. So in order to earn the match, you’ll need to contribute as well.

For example, your company may match your contribution 50 cents for every dollar you contribute, up to 6%. Okay, okay. What’s that all mean? Put more simply, this means that if you contribute 6% of your salary in a year, your company will match an additional 3% of your salary--from their own funds! It’s completely up to your employer how much they will match and what the terms will be.

Quick tip: Sometimes a company match will go directly into company stock. This can seem like a nice perk and feel like even more “skin in the game,” but it lacks diversification. For most, it’s best to regularly move your company stock into a more diversified mutual fund (on a quarterly or annual basis).

Employers are catching on to the value of a 401(k) match to their employees. A 401(k) match can be a big boost to employee morale when an employer shows interest in their future financial security. I recently gave a financial presentation to a business which gives a 100% employee match up to 11%! That means if the employee puts in 11% then the company contributes an additional 11%. Those employees likely aren’t going anywhere!

The impact of a 401(k) match on your retirement

Let’s use an online retirement calculator to illustrate the impact of a company match on your 401(k), compared to receiving no match. For this exercise we’ll assume the company matches 50 cents for every dollar, up to 6% of your salary. So earning your full company match would mean your company contributes an additional 3% of your salary to your 401(k).

Your contribution: 6% of your salary
Company’s contribution: 3% of your salary
Your salary = $40,000

Your contribution = $2,400 (6% of salary)
Company’s contribution = $1,200 (3% of your salary)
Total contribution = $3,600

Future value of 6% contribution + full company match = $934,412
Future value of 6% contribution + no company match = $718,777

Earning the full 401(k) match in this illustration would have earned you over $200,000 extra over time! We are assuming here that you start at age 30 and end at age 65, and that the average rate of return over that period of time is 8%.

But we left out a big assumption that can produce even more wealth: a salary increase! Remember, your employer’s match is a function of how much you earn. If you earn more, they contribute more dollars. If we assume an annual pay increase of 3% and 6%, here’s what happens:

...your employer’s match is a function of how much you earn. If you earn more, they contribute more dollars!

3% average annual pay increase
Future value of 6% contribution + full company match = $1,298,350
Future value of 6% contribution + no company match = $998,730

6% average annual pay increase
Future value of 6% contribution + full company match = $1,913,179
Future value of 6% contribution + no company match = $1,468,982

Have I convinced you yet of the value of earning your full 401(k) match?

Why you may be leaving your match on the table

So why are there so many people going without their 401(k) match? There are a few possibilities and solutions I’d propose.

1. You don’t know the amount of your full company match

Frankly, some companies aren’t great at regularly communicating to their employees the benefits of their 401(k) plan. Even if communication does happen, employee matching rates may change from time to time.

It’s probably best to talk to your Manager or HR department to make sure you know the amount of your full company match. Also, check in with them occasionally to see if the terms have changed at all. Earning at least your full company 401(k) match is crucial.

2. You don’t feel like you can contribute more

I get it. Cash is tight. After paying your mortgage, utilities, car payment, and buying gallons and gallons of milk for your kids, it doesn’t feel like there’s much money left to boost your retirement savings.

I’d propose you try a couple of things. First, create a simple budget. Doing so will give you an idea of what you’re spending on the Essentials (like your mortgage and gallons of milk), and what you’re spending on the Non-Essentials (dining out, extra clothes, or unnecessary--but very cool--electronics). Once you’ve identified your Non-Essentials, you can “dig deep” and start directing at least some of that money toward your 401(k) to get your full match.

Second, trick yourself by “contributing by degrees.” Psychologically, it’s pretty hard for us to switch from contributing 5% to 10% overnight. So what it each year you increased your contribution by just 1 or 2%? The financial impact of this would be less severe, and you may not even miss the money that would have otherwise ended up in your bank account.

3. You’re afraid of putting too much into the stock market

I can’t guarantee how the stock market is going to perform, nor can I predict when the ups and down will come.

But the potential retirement problem we all likely face is the time will come when we either cannot continue working or we don’t want to. In order to prepare for that time, you need to save and/or invest enough to generate future income.

There are many ways to do this besides retirement accounts--rental properties, residual business income, selling your first-born child (kidding, don’t do that)--but I personally believe having a 401(k) is one of the best ways to build wealth for retirement, for the following reasons:

  • The company match
  • Significant tax saving advantages
  • Passively managed investments requiring less “maintenance” compared to other options
  • Diversification through mutual funds

I hope this article has helped you consider one of the biggest advantages of your 401(k)--your company match! Consider the long-term impact your employer's match can have on the potential growth of your retirement nest egg. At the very least, contribute enough to earn the full company match. After all, it’s free money!