The 401(k) plan is the most popular employer-sponsored retirement plan today. Sixty-five percent of employers offer a 401(k) or similar plan to their employees. The world today has largely shifted the burden of retirement savings from the employer to the employee. Long gone are the days when everyone was promised a pension on day one of retirement. You may be reading this and say to yourself “I have a pension!” You very well may, pensions aren’t completely extinct but have been widely replaced by defined contribution plans, like the ever-so-popular 401(k) plan.
The Employer Match
Saving your own money is a lot less fun than being promised a set amount of money in retirement by your employer. But, saving your own cash isn’t all that bad! Many 401(k) plans will have a match if you contribute a certain percentage of your pay. If there is a match for your plan it will be stated in a document called the Summary Plan Description (SPD), which outlines all the plan provisions. Get your hands on this document or reach out to the person in charge of benefits if you are unsure of your company’s match.
Once you get your hands on the SPD find the section that discusses employer contributions. It may be spelled out directly or it may say something like, “The employer will match 100% of the first 3% and 50% on the next 2%.” This type of language is not all that easy to decipher but what that really means is if you put in 3% of your pay, your employer will also put in 3% of your pay. If you put in 4% of your pay, they’ll give you an additional 0.5%, so a total of 3.5%. If you put in 5% they’ll give you the 3%, plus 0.5%, plus another 0.5%, so a total of 4%. If you’re more of a visual person, like myself, refer to the chart below.
|
Your contribution |
Your employer’s match | Total contribution |
Lost match |
|
0% |
0% | 0% |
-4% |
|
1% |
1% | 2% |
-3% |
|
2% |
2% | 4% |
-2% |
|
3% |
3% | 6% |
-1% |
|
4% |
3.50% | 7.50% |
-0.5 |
|
5% |
4% | 9% |
0% |
In this scenario if you put in anything less than 5%, you’d be leaving money on the table. That’s essentially free money! Now, you will have to pay tax on that money once you start taking distributions from the plan, but it goes in pre-tax and grows tax deferred.
They key takeaway here is to find out what the matching formula is and contribute enough so that you aren’t leaving any money on the table. Free cash should be reason enough to start contributing to the company 401(k) but there are other benefits to take into consideration as well.
Higher Contribution Limits
401(k) plans have much higher contribution limits than Individual Retirement Accounts (IRAs). If you are under age 50 in the year 2019 you can put a whopping $19,000 into the plan, if you’re over 50 you can put up to $25,000 into the plan. These limits are just on your dollars, that does not include any match your employer may put in.
Autopilot Features
Some employers will enroll new participants into the plan automatically, this is called auto-enrollment. With auto-enrollment will sometimes be an added feature called auto-escalation. Auto-escalation increases your contribution each year without you having to do anything, usually this increase is 1% of pay. Some plans will allow you to add this feature yourself even if you aren’t automatically enrolled. Adding auto-escalation yourself can be a painless way for you to increase the amount you are saving over the years without noticing large differences in your take home pay.
Roth Option
Another added benefit is the Roth option. More and more employers are adding the Roth option to their existing 401(k) plan. While you may not get an immediate tax break like you would with traditional contributions to the plan, you will have tax free distributions in retirement, like you would with a Roth IRA.
Summary
This is not an extensive list of benefits and like with anything you will want to weigh the benefits of contributing to plan versus saving in another account. You will especially want to pay attention to the cost and selection of the investments offered, even small differences in costs can have a significant impact on your investment over time. It’s also important to watch out for vesting schedules. If you leave your company before you are fully vested, you will be forfeiting a portion of the employer match that went into your account. The 401(k) is not the be-all end-all for retirement savings but it’s a great place to start.