For many employees, a 401(k) plan or similar defined contribution plan is the biggest retirement asset they have. The goal is obviously to grow that investment as much as possible and a company match can help accelerate that process.
I’m in a fairly lucky situation at work. My company has a pretty unusual match. In a nutshell, they throw in a company match of 35 cents on the dollar.
Did you notice I didn’t say “… up to 6%” or anything like that?
That’s because we don’t have a limit on our match. In other words, if an employee at my company contributes the max into his/her 401(k), which is currently $18,000 (at least through 2017), they will have received an additional $6,300.
$6,300 in free money per year for doing nothing but saving as much as possible for retirement. That’s pretty mind-boggling to me. That’s a return on investment before you even get to “roll the dice” in the stock market.
Why is a company match so important?
I know that the company match I receive is pretty unusual, but most companies offer some type of match – some better and some worse. It’s so important that you take advantage of it. Yes, that additional money is fantastic to have in general, but the more critical aspect of that free money is to realize just how much the magic of compounding will take hold on it.
According to Investopedia, the most common employer match is 50 cents on the dollar of up to 6% of your salary. So let’s use that to see how important that company match can be. Let’s also assume an income of around $44,510, which is the average personal income of a worker in the U.S. in 2015 according to Wikipedia.
So let’s say that Joe Bob (I always wanted to use someone named Joe Bob in an example!) was putting the max into his 401(k) plan and his company match was as mentioned above…
Joe Bob’s annual contribution: $18,000
6% of his salary is $2,670.60
Half of $2,670.60 (in other words, 50 cents on the dollar): $1,335.30
So Joe Bob is getting $1,335.30 in free money every year!
Wow, big deal, Jim – just over $1,300 a year in Joe Bob’s 401(k)… over 20 years, that’s only $26,000 per year. No one’s retiring on that!!
That’s true, but that’s without taking the power of compounding into consideration. Let’s look at that and see how that number changes.
Using a compound interest calculator, I’m going to put in a starting amount of $0, assume a rate of return of 7%, and enter Joe Bob’s company putting in $111 as a match for him every month. Compounded annually, that gives him an estimated total of $56,655 after 20 years.
In other words, compound interest has helped Joe Bob get over $56,000 in free money from his employer!!
Also, pretty important to that whole idea is that Joe Bob was maxing out his 401(k) for 20 years. Check out this really cool Reddit link which shows how easy it is to suddenly end up with a million dollars!
Your company match is probably different from my example I gave because it seems like employers are all over the map on this, but the point is, there’s a lot of free money out there that your employer is likely offering you.
As a side note, after doing the same calculations with my employer’s company match, an employee there would receive $267,963 after 20 years when figuring in the same compounding effect and rate of return.
Of course, that only matters if you’re contributing to the plan…
Stop it, Jim… why would anyone not be contributing to a plan with a good company match like that?
Good question. I don’t have the answer but I can tell you that, although most employees at my company do contribute, many of them are putting in next to nothing.
I don’t get the scoop from human resources on the exact numbers for each person (and I don’t think legally she is allowed to provide them), but I do like to talk to the guys and gals that work there just to see what they’re doing. Here are a couple of examples I’m not proud of…
One guy (an engineer) told me he contributes $5 per pay period, which is every two weeks. That’s only $130 per year! I get it – his wife has a pension so that’s good, but even if we just focus on the company match, he’ll get about $5,614 after 20 years with our compounding numbers we used above. That means he’s missing out on around $262,349 of free money… what??!!!
I have another guy there who doesn’t contribute at all because he’s investing in rental property. And I get it – I’m going to be shopping for another rental property soon as well – but it’s hard to realize that he’s passing up 35 cents on every dollar invested. Most likely his rental property is going to give him a return of maybe 10% if he’s smart about his investments. Look, 10% is fantastic and I definitely agree with spreading the risk by buying something tangible, but that means he’s giving up a 25% return right off the bat. And that’s before the market hopefully goes up over time!
That’s not to say that everyone is on that same path. We do have a number of people there who contribute the max every year, but I think most of the employees there (and companies everywhere) just don’t seem to get it. We’re an IT company with some extremely smart people – including many highly-trained engineers – but it’s really as if they don’t even want to think about retirement.
Everyone’s situation is different but please realize that the company match from employers is huge. I can’t think of anywhere where I can get an instant 35% return on my money with no effort. Even if your employer doesn’t give you that same match, if they offer some type of company match, make sure you’re taking advantage of it. The rule of thumb is to first contribute up to the employer match and then start looking at other investments. I hope most of you reading are doing exactly that.
If you have a defined contribution plan at your work like a 401(k), 403(b), etc., does your employer offer some type of match and are you taking advantage of it?
Thanks for reading!!