The term 401(k) gets thrown around so often but so many employees have no idea what the plan is or how it benefits them. A 401(k) is free money that your employer is trying to give you. All you have to do is accept. If you’re not utilizing your company-sponsored 401(k), you are really missing the boat. Let me explain how this benefit works.
In a very cursory view, a 401(k) allows you to set aside money from each paycheck for your retirement. The true benefit though is that your employer will match what you set aside up to a certain point! In most cases, a company will match dollar-for-dollar what the employee sets aside, up to 6%.
Let’s take a look at a very simple example. For the sake of easy math, let’s say that you make $52,000 per year. You receive $1,000 a week before taxes or $2,000 every paycheck if you are paid twice a month. If you agree to set aside 6% for your 401(k), you will automatically have $120 taken from each of your paychecks. Your company will also add $120 to your account so you will end up with $240 per paycheck going toward your retirement! That is free money! Why would you not take it?
Common sense tells you that if your company is trying to give you a 6% raise, you should take it immediately but so many people do not. The reason most commonly cited is, “I just can’t afford to have 6% taken from my paycheck.” This is no excuse. If you are using every penny of your paycheck for expenses, some work needs to be done to lower your cost of living. Are you spending too much eating at restaurants or paying too much in rent? Scale back! You cannot afford to ignore the 401(k)! In this instance, if you are living at a bare-minimum and are coming up a little short, this is the time to use your credit cards. Even if you are paying 21% in credit card interest, you’re earning an astonishing 100% return on your money through your 401(k)!
Another complaint I hear from people is, “My company is only matching up to 6%. What difference will that make?” It is absolutely huge! Let’s take a look at someone making $30,000 per year. A 6% contribute will be $1,800 per year. If you put in your part and the company adds another $1,800 to it, you’ll have a decent chunk of money when you’re ready to retire! After 30 years in the 401(k), if your investment earns a modest 7%, you will have accumulated $340,058! If you earn only 1% more on your investments, you cross the $400,000 mark and end with $407,819! All of this for only giving up 6% of your check!
If you don’t think you can afford to give up the 6%, think again. Give it a shot and you’ll be surprised at how easy it is to contribute. You will surely get used to your checks being slightly lower than usual and your spending will adjust. Reverse your thinking–you cannot afford not to contribute!
Naturally, there is a lot more that goes into a 401(k) plan so do your research online or consult a financial adviser. Your company’s Human Resources department can also be a great resource for learning more about this benefit. The point is, when someone offers you free money, you take it.
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27 Responses From Our Readers
1.) Google Payload at November 21, 2007 around 3:42 am
This is why most americans like myself are in debt. Not thinking about the bottom line as much as the next toy we can accumulate. Im no exception. It sometimes seams like the biggest saver is the biggest looser in terms of life experience and entertainment. This is the mindset of the younger generation anyway. Rack up credit card debt but forget about saving the 6% that is matched by the company.
2.) Igor at November 21, 2007 around 3:47 am
Interesting article.
One thing here - You don’t really want people to use credit cards just to make sure they get their 6% from the employer. Think strategically - do you need a credit card debt with 21% per annum or you want debt-free life, but without your 6% match?
3.) financial hack at November 21, 2007 around 4:15 am
The true benefit though is that your employer will match what you set aside up to a certain point! In most cases, a company will match dollar-for-dollar what the employee sets aside, up to 6%.
Unfortunately, that just isn’t true. Some company’s match, some don’t, rarely do they match 100% these days. It varies greatly so you need to look at your company. But it does make sense not to pass up free money in the 401(k) if your company does match a certain percentage.
4.) Austin at November 21, 2007 around 4:23 am
Hmmm, an interesting insight…I’m a college grad, so I knew NOTHING about 401ks until now.
Oh, and the author does have a point. The reason a lot of people choose not to opt into the 401k plan beside their having other more attractive investment plans is that they’re too spendy! A national credit card debt of $3 trillion, and an average savings rate nationwide that’s negative, and ever-plummeting…hmmmmmm…..
This is why I really value how my parents raised me. I was hardly ever spoiled, and even as I gain more financial independence, I’m still saving! I might still dump money on big-ticket items, but somehow, I still do well..
5.) ace at November 21, 2007 around 4:26 am
My company will match up to 2% only if you put in 4% or more. This is still free money, so I do it. You would be a fool not to.
6.) 70311 at November 21, 2007 around 5:00 am
Great summary article. You should write a followup showing all the tips for how to choose which plans to go with. That’s the part I have no idea on.
7.) CPAinChicago at November 21, 2007 around 5:57 am
Yeah, this is all great provided that your company will match…
Most don’t anymore for exactly this reason.
8.) Sagus at November 21, 2007 around 9:33 am
I certainly wish I could get that deal.
I work for local law enforcement - no match at all - and no pension (which is why I’m looking for other employment…I always thought a pension was the main reason for working a .gov job)
My wife works for a national clothing store - no match at all.
9.) Jaja John at November 21, 2007 around 9:37 am
This is what all Americans needs to know. What about if your company doesn’t match up anything, would you still take it?
10.) froinlavin at November 21, 2007 around 10:04 am
You forgot to mention that 401k contributions are taken out of your paycheck on a pretax basis. Not only will (some) companies match your contribution, but you lower your tax burden at the same time.
11.) Gordon Hepburn at November 21, 2007 around 10:43 am
Many matching contributions are “vested”. You have to work several years, perhaps as much as ten, before you are entitled to all of the employer’s matching contributions.
Also 401(k) plans are complex: Try reading the “Summary Plan description”: if you don’t understand it, think twice about joining.
And if you ask your employer for all the formal legal documents defining the 401(k) plan, don’t expect them to be handed over willingly.
And when you leave a job, and attempt to get your money transferred out of one 401(k) and into another, or into an IRA, be prepared to deal with paperwork. It can be difficult.
I have seen non-English speaking employees (Mexicans, Vietnamese, Cambodians, etc.,) walk away from their paltry 401(k) money which they could ill afford to contribute in the first place because they couldn’t handle the paperwork.
They told me that they joined the 401(k) just to keep the job! They thought that if you didn’t join you would be fired for being a Commie troublemaker!
And if you think that after keeping your money for twenty years or so the plan trustees and adminstrators are going to hand it back to you, you are an deluded optimist.
401(k) plans are not nowadays designed primarily for the employees benefit: they provide financial benefits to the financial services industry, and the employers.
If you have a problem with your 401(k), be prepared for a headache with the administrators, the trustees, the Department of Labor, the IRS, etc., etc. And in the current Bush administration all these organizations work for the employer, not the employee.
(”A bird in the hand is worth two in the bush”?)
To be fair, the Clinton adminstration was no better.
Best of luck: Remember Enron!
12.) Doug at November 21, 2007 around 11:20 am
Gordon,
You seem very angry, but you are misunderstanding 401K’s to a great degree. I have changed employers quite frequently, and it has always been simple to get the money out and roll it over to an IRA.
Your employer does not have control of the money. Generally, they do not even manage the plan. An outside firm (such as Fidelity or Nationwide, or some local financial services company) manages the 401K.
Granted, 401K’s are not perfect. Fees are often hidden, and can be quite hefty, especially for plans with only a few participants. Also, your investment choices can be quite limited. But that’s it, I can’t think of any other negatives.
Even if your employer doesn’t match, 401K’s are still the best thing going. I max out my 401K contribution, and it reduces my income tax by about $3800!
I think the biggest mistake made by employees is to not contribute enough to retirement plans. Another common mistake is to invest to conservatively. Also, many people do not properly diversify properly.
13.) Chuck at November 21, 2007 around 11:42 am
Good post. Many people don’t realize there is “free money” to be had.
If you are interested in reading more, check out http://www.chuckmckenzie.net/2007/11/how-to-set-up-your-retirement-account, which can help get you started on the right savings path. The earlier you start saving, the more time the money has to grow.
14.) MWB at November 21, 2007 around 12:58 pm
The 401K is yet another scam designed to liberate working peopleof cash to create a nice pool of NEW money that generates share windfalls for the Wall St. thugs who are destroying America. If your company files for Chapter protection (an acceptable business practice today) you WILL lose your contributions. Mergers? Acquisitions? Guess who wins and guess who loses.
15.) Dave at November 21, 2007 around 2:11 pm
I don’t bothger with 401k, because do you really think that money will be there when you retire? You must think the Social Security you pay will be there too, right?
(The answer to both is NO)
16.) Gordon Hepburn at November 21, 2007 around 2:11 pm
Doug, I am not angry.
And I understand 401(k) plans more than most of the employees who are coerced through employer pressure into joining them.
Like you Doug, I too have been involved with several 401(k) plans. Only one or two of them were participant-friendly. Most were bureaucratic and authoritarian.
Every employee should read the 401(k)’s vesting rules carefully. And compare the glossy plan brochures with the Summary Plan Description and the actual plan documents (if you can get them).
Unless you really understand where your money is going, you are taking a chance with a 401(k).
Only after you have investigated the plan thoroughly should you consider joining.
Therafter, you have to watch your 401(k) money like a cat over a mousehole.
Because, if anything goes wrong, you are probably on your own.
If you want anger, Doug, read about the Enron participants, and the legions of other 401(k) plan participants, who have struggled in vain to get their money from “frozen” or defunct 401(k) plans.
Actually, I don’t see why employers should be involved in 401(k) plans any more than they should be involved in health plans.
As far as I can recall, 401(k)’s were originally created to reduce the taxes of highly paid employees, and they morphed into the glorified tithing system that they are nowadays.
I have seen plan promoters use peer pressure and sales pitches to coerce illegal Mexican workers on an assembly line to join 401(k)’s.
This sort of thing would make any reasonable person angry.
17.) Eddie D. at November 21, 2007 around 3:09 pm
A full 6% match would be VERY generous. At my company we get 50% for the first 3% and 25% for the next 3% (resulting in a 2.25% match if you do the 6%), which is among the lowest I’ve encountered.
18.) links for 2007-11-22 « Romulo Lopez Cordero at November 22, 2007 around 2:20 am
[…] Don’t Give Up Free Money. A Look At Your Company’s 401(k) Plan The true benefit though is that your employer will match what you set aside up to a certain point! If the company does that in my case there is no matching. Is there any benefit without the match? (tags: business Finance health money) […]
19.) Paul at November 26, 2007 around 1:24 pm
A 401(k) is not always the right thing.
This article assumes your company has a 401(k) plan.
This article assumes your company has a favourable vesting schedule - some don’t allow you to fully vest in their match until you have been with the company for 4 years and some don’t even allow partial vesting until you’ve been there at least 2 years.
This article assumes your company matches dollar for dollar. The average corporate match is 50 cents to the dollar, and only up to 6 percent.
This assumes you’ll like the 401(k) investment fund options you are getting - some of the funds have massive sales loads, such as 5 percent the first year and 2 percent each year thereafter.
20.) Paul at November 26, 2007 around 1:25 pm
This is brillance? Ugh.
21.) unsleepable at November 29, 2007 around 2:18 am
[…] Don’t Give Up Free Money. A Look At Your Company’s 401(k) Plan! "A 401(k) is free money that your employer is trying to give you. All you have to do is accept. " It’s true. Read and learn. […]
22.) 36 Ways To Save Some Extra Cash Each Month at November 29, 2007 around 2:58 pm
[…] In Your 401(k) If Your Company Matches. I’ve written about this before so no sense in rehashing it here. If your company offers contribution matching with a 401(k) plan, […]
23.) Paragon wealth at January 30, 2008 around 4:37 pm
A 401(k) is a great plan. Excellent article!
24.) Ron at February 10, 2008 around 6:33 pm
I always hear people at work justify their non-participation in our company’s plan by referencing Enron and how everyone there lost out. Our company isn’t even publicly held and thus company stock isn’t even an option. I just don’t even bother talking about it anymore. I believe many people are just determined to not invest.
25.) Ron at February 10, 2008 around 6:38 pm
I don’t make alot of money and I haven’t noticed any lifestyle changes since the inception of my contribution of 15%. Makes a person wonder just how much money he unknowingly wastes.
26.) Lisa at March 19, 2008 around 10:28 am
After the past 6 months with the market down-turns, watching my 401k monies dwindle away, I decided to jump out of my 401k, for at least the next quarter. This brings my contributions down to zero, and my employer still kicks in 3%…called “safe harbor” amount. I’m vested 100% in whatever the company kicks in, so it’s actually my money (free money) they send to the 401k plan.
I was told when I decided to jump out, that any losses I’ve had are “funded” by the employer, so I shouldn’t worry. However, a quick check of my 401k funds since Jan. of this year shows that I’ve lost over 4000.00 dollars so far…and that comes no where near what my company has kicked in.
I found that kinda strange, because….if it’s your money (vested 100%) - even though it is considered “free” money,…why would it still be considered ok to lose it? I mean…yes the employer was kicking in more than me, but,…even though it’s “free” money, it’s still my money in the end. Why should I be ok with losing it to a down-turned market, just because it was “free” money. It’s still my money…I still want to save as much of it as possible…no?
27.) joe at November 17, 2008 around 12:02 pm
All was fine till you tried to get your money from these 401K institutions. Many are insurance companies that were begging for money from the govt. I’m supposed to trust my money to these companies on the verge of bankruptcy ? Think again.
There is no such thing as “free money” that the company is trying to hand you. The company has to do something to benefit the CEOs.
There’s no FDIC or anyplace safe in your 401K - when the company holding the money goes belly up……good bye money.
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