One-Third of Plan Participants are Giving Away Free Money … Are You?

By Jeffrey Levine, IRA Technical Expert
Follow Me on Twitter: @IRAGuru4EdSlott

One of the most common questions retirement savers ask is, “Where should I be saving for retirement? Should I be saving in my employer’s plan? An IRA?” While there’s no one-size-fits-all answer to these questions, if your employer offers a match, it is almost always best to save your “first” retirement dollars in your employer-sponsored retirement plan (i.e. a 401(k)) each year – at least until you max out employer-provided matching contributions. After that, where you should save your next retirement dollars becomes a much more personal decision.

For those not familiar with “the match,” it’s simply an employer’s promise to put money into your 401(k) or similar plan, up to a certain amount, based on a formula established by the plan. For instance, your plan might offer a 50% match on your contributions up to a maximum of 6% of your salary. Therefore, to get the maximum employer match, you’d need to put 12% of your salary into the plan each year.  Let’s put some numbers to this in order to make things a little easier to understand.

Let’s imagine your salary is $100,000 – this way we can keep our math nice and easy! Continuing with our example from above, if you contribute 12% of that amount – $12,000 – to your plan, then your employer will deposit an additional $6,000 – 50% of what you contributed – into your plan account on your behalf. If you contribute any more of your salary that’s great, but it won’t get you any additional employer-provided funds because you’ve already reached the plan’s match cap of 6% of your salary. On the other hand, if you contribute less, you will get less from them too. For instance, if you only contributed $8,000 – 8% of your salary – you’d “only” get a 50% match of $4,000 from your employer.

It’s been said by many that “there’s no such thing as free money,” but employer-matching contributions are about as close as it gets. In our example, it’s like making an instant 50% return on your contributions (up to the maximum match). Some employers offer a dollar-for-dollar match, which is even better. That’s like making an instant 100% return on match-eligible contributions. Either way, it’s a pretty sweet deal.

Note: If your plan offers a match and a Roth option, regardless of whether you defer funds into the traditional side (pre-tax) of the plan or the Roth side (i.e. a Roth 401(k)), your employer must deposit matching contributions to the traditional side of the plan.

…And that’s why as a general rule, your first retirement dollars saved each year should be in your employer-sponsored retirement plan if there’s a match. It’s also why you should do everything in your power to make sure you’re contributing enough to your plan to get the maximum match from your employer. Otherwise, you’re just leaving “free” money on the table. You’d like to think that this would be a relatively rare occurrence, but unfortunately, it’s actually fairly common.

Consider that, according to a recent report by Vanguard, a little more than one-third of people deferring money into their employer-sponsored retirement plan were not taking advantage of their employer’s full match (Note: the report was based on an analysis of certain plans held with Vanguard). Yes, you read that right. One in three people is coming as close to giving away free money as you can get! And it gets even worse.

Some 55% of plan participants in auto-enrollment employer plans – which are becoming more and more popular – are contributing less to their employer-sponsored retirement plan than the amount they need to contribute in order to receive the maximum employer-provided matching contribution. This is strong evidence that these participants are basically “going with the flow” and choosing the default contribution rate selected by their employer rather than actually taking the time to figure out which contribution rate will be most beneficial.   

Don’t make that mistake! If you’re still working and your employer offers a 401(k) or similar plan, take some time to find out all the features of the plan. You can usually do this by requesting what’s called a summary plan description, which is often available online, or by speaking with a representative from your HR department or from the plan directly. Make sure you learn about all of the important features, including what matching contributions, if any, are offered. And make sure to know the answers to these other frequently asked 401(k) questions as well.

While everyone’s situation is different, and there are occasionally reasons to buck the general rule, remember that, if at all possible, it generally makes sense to contribute as much as necessary to get the full match and avoid leaving any of that free money on the table.