401K Match Left on the Table?

Many company retirement plans offer a 401K match, and allow employees to contribute anywhere from 1% of their pay up to 75% of their pay. The match is given every week that the employee contributes. There are two ways to miss out on the company 401K match, by not contributing at all, and by contributing too quickly.

The people who miss out on the 401K match the most are those who feel they can not afford to contribute to their 401K. As far as affordability goes, the retirement savers tax credit makes a big difference in affordability.  Low earners can receive up to a 50% credit.

Look at this example: Joe is single and earns $17,000 a year, making just a bit over minimum wage.  He lives paycheck to paycheck and doesn’t think he can afford to put in 6% to get a full $1 for $1 match on his 401K.  6% is $1,020 a year, or $19.61 a week, let’s round that to $20 a week, which is a lot in Joe’s world.  Now since his income is under $18,000 for the year, he can get a tax credit for 50% of his contribution.  This effectively makes his weekly contribution $10.   He is in the 10% tax bracket, so he also receives a 10% deduction for his $1,020 contribution, which reduces his net expense further to $8 a week, which makes retirement savings much more affordable.

If he never earns any more money (which I’m sure he will, Joe’s a smart hard working guy!) at 8% returns over 35 years, contributing his $1,020, while his employer puts in a $1,020 401K match, he will have $380,000 in his 401K.  This isn’t a fortune, but it’s a world different from $0.  At a 4% withdrawal rate, this amount of wealth can generate $15,200 a year in income, replacing virtually his entire after tax income, and all he had to contribute was $8 a week, or $14,560 total.  As far as cash flow goes, Joe can adjust his tax withholding down to reflect his new tax credit, this will give him the cash flow needed to offset the $20 out of his check every week.

On the other side of the coin are those who max out their 401K before the end of the year. Companies match 401K contributions every paycheck. By contributing the max to a 401K before the year is up, the employee will miss out on those matching dollars for the rest of the year.

Let’s look at 2 employees, Bill and Bob. Both are earning $100,000 a year and are excellent savers. They work for the same company and are both offered a 5% dollar for dollar 401K match. Bill sets up his 401K so that he pays the max over the course of the year, contributing 17.5% from his paycheck. Every week his employer puts in a 401K match and at the end of the year, Bill has contributed $17,500 and his employer contributed $5,000.

Bob wants to fund his 401K as quickly as possible, to free up cash flow in later months. Bob has low expenses and can live off of a small percent of his salary. He decides at the start of the year to contribute 50% of his weekly pay to his 401K, or $962 per week. His employer matches the first 5% for $96 per week. In 18 weeks Bob has fully funded his 401K. For the rest of the year he can not put any more money in. His company 401K match for his contributions over 18 weeks amounted to $1,728. Bob lost $3,272 in matching funds by saving too quickly. And the really bad news is that he lost the future value of that money compounding over the rest of his working life.  What if he did this for 30 years? At 8% annualized returns, without any deviation in income, he would have lost $400,000. ($272.66/mo contributed for 30 years and invested at 8%)

It is important for those who are maxing their 401Ks to do the math to find out what percent to contribute to ensure they can contribute all year and receive the maximum 401K match for their employer. It’s a simple calculation:  Max Contribution (17,500 for those under 55 in 2014)/ Gross Salary = Percent to contribute.  Look into your company’s 401K, find out if one is offered, and if you are maximizing the 401K match being offered.  Leaving what looks like a few bucks on the table now turns into a mountain of cash later on.