Too many Americans underestimate the value of their employer-sponsored retirement savings accounts, particularly if the employer is willing to match some, or all, employee contributions. While the majority of workers with 401(k) plans contribute more than enough to take full advantage of their employer's matching program, there are still about 20% of people who don't.
This is perhaps one of the worst retirement mistakes you can make. Sure, it doesn't seem like a ton of money to be missing out on now, but you might be surprised at how much of a difference it can make when you eventually retire.
One of the worst retirement mistakes you can make
About 75% of companies offering 401(k) retirement plans offer some type of a matching program, generally based on an employee's contributions capped at a percentage of their salary. For example, a 401(k) matching policy may be "50% of employee contributions, up to 6% of total compensation." In other words, if you earn $50,000 per year and contribute $3,000 to your 401(k) -- 6% of your salary -- your employer will contribute an additional $1,500 on your behalf.
However, about one in five participants don't contribute enough to take full advantage of their employer match, according to several different surveys. Besides cashing out your 401(k) and spending the money, this is perhaps the worst retirement savings mistake you can make.
Why the employer match is so important
Here's a simplified example that shows why this is so important. Let's say that you earn $100,000 per year and that your employer will match 50% of your contributions, up to 5% of your salary. So, you choose to contribute $5,000 into your 401(k) each year and your employer matches 50% of your contributions for a total of $7,500 flowing into your account annually. Over a 30-year period, your account could be expected to grow to approximately $708,000, assuming 7% annualized investment returns.
On the other hand, let's say that you choose to contribute just 3% of your salary, which is a common automatic contribution level set by many employers. Including the employer match, this means that just $4,500 will go into your account per year. Each year, you're missing out on $1,000 in employer contributions that you could have received for contributing the 5% matching limit. What's more, a move like this can really add up over time -- assuming the same 7% annualized returns, your account would only grow to about $425,000. That $283,000 difference could have a big impact on your financial security after retirement.
For this reason, the maximum contribution level your employer is willing to match should be the bare minimum you choose to put into your 401(k). Not doing so is literally turning down free money. Would you turn down a raise? Of course not. Not taking advantage of your employer match is just as silly.
It may seem like a lot now
This is an especially common mistake among younger people just starting out in their careers. Understandably, if you're starting your first job with an employer-sponsored retirement account, choosing to effectively reduce each of your paychecks by 5% or more to contribute to a retirement account may seem like a lot of money.
Plus, as I briefly mentioned earlier, many employers' 401(k) plans have automatic enrollment for new hires, often with a low contribution rate such as 2% or 3%. Many workers simply don't think to change it.
However, it's important to think about your employer's matching contributions as what they really are -- a part of your compensation that you miss out on if you don't put enough into your retirement account.
The Motley Fool has a disclosure policy.