Previous generations, such as your grandparents or great-grandparents, often retired on pension plans. Pensions and other defined benefit plans involve companies setting aside pools of money to fund living expenses for their retired employees. However, companies have steadily moved away from these plans in favor of defined contribution plans, which assign workers the responsibility of saving for retirement.
In other words, retirement planning is more important than ever today -- it falls on you!
The 401(k) is the most common defined contribution plan. According to the U.S. Census Bureau, over a third of working-age Americans have a 401(k) or similar plan.
Fortunately, the 401(k) has some cool perks, making it an excellent retirement tool. It defers the taxes on the money you contribute until retirement and has very high annual contribution limits. That should be music to your ears because it means you can aggressively save and lower your yearly tax burden throughout your working life.
Too many people fall short of their retirement goals
Unfortunately, many people struggle with the burden of retirement planning. According to the 2022 Survey of Consumer Finances, the median person aged 65 to 74 (when most retire) has approximately $200,000 saved. Many financial planning experts recommend retiring with around 10 times your annual salary. The typical American worker's yearly salary is just shy of $64,000.
Image source: Getty Images.
Do the math; people are retiring with about $400,000 to $450,000 less than they should.
That puts most people on thin ice during their retirement years when they are most vulnerable because they may be unable to work. It's crucial to understand how vital retirement planning is, and the 401(k) can be such a powerful asset to help you. If you have a 401(k), ensure you do everything possible to maximize it.
That includes one tip I tell everyone I can.
Approximately 20% of 401(k) participants leave easy money on the table.
Most companies offering 401(k) plans also offer a 401(k) employer match. It's a financial contribution to your 401(k) your employer makes on your behalf. The catch is that you must contribute to your 401(k) to earn it. Aside from that, employer matches generally don't have any strings attached, other than some employers requiring you to abide by a 401(k) vesting schedule.
Here's how it works.
Employer matches are usually a dollar-for-dollar match (or a ratio) up to a certain amount of your annual salary. So, suppose company ABC matches dollar for dollar up to 5%. If you make $100,000 and contribute 5% of your salary ($5,000), your employer will contribute an additional $5,000 to your 401(k). If the match was 50% instead, the company would add $2,500 to your $5,000 contributions that year. That's an instant 100% or 50% return on your money!
That means anyone who does not contribute enough to earn the maximum employer match is passing on easy money. Fidelity, one of the largest 401(k) plan administrators, estimated that only 78% of its 401(k) participants earned their full match in 2023. Everyone has different circumstances. Anyone struggling to meet basic financial needs has more pressing matters at hand. I'm speaking to those who can afford to earn their full 401(k) match but aren't.
It goes beyond the easy money. Here are the underlying benefits of the employer match
Yes, the employer match in a 401(k) is easy money, but the benefits go beyond the dollars and cents.
The entire purpose of the match is to incentivize people to save more money for retirement. That's why you can't earn that money unless you contribute first. Given the financial shortcomings of most modern retirees, I'd say that's very important.
It also is a game-changer for most people who aren't high earners. Thanks to the match, you don't need to earn a six-figure salary to enjoy a comfortable retirement.
For example, consider person A, who is 30 and earns an average U.S. salary of $64,000 with 2% yearly raises. Their 401(k) plan features a dollar-for-dollar match up to 5%. They work until age 65 and invest their retirement savings to generate 8% annualized returns for 35 years, retiring at 65. They earn their full employer match year after year. Person A would retire with approximately $1.46 million. Someone without a 401(k) match earning $125,000 and saving 5% of their wages (same age, raises, time horizon, and investment returns) would retire with $1.42 million.
What's the lesson here? Take full advantage of the tools aimed at helping working people fund a proper nest egg -- starting with the 401(k) match.
