As Many as One-Third of Americans Are Making This Massive 401(k) Mistake. Are You One of Them?

The typical employer with a 401(k) plan will contribute between 3% and 6% of an employee's compensation on their employees' behalf. But to take advantage of this, employees need to contribute money themselves, as these are known as matching contributions.

According to several sources, far too many Americans are leaving money on the table by not taking advantage of their employer's matching contributions. A 2021 survey by personal finance site MagnifyMoney found that 17% of people with access to an employer-sponsored retirement plan don't contribute at all, and of those who do, 12% don't contribute enough to get all of their company's matching contributions.

Furthermore, a Vanguard study found that 48% of 401(k) participants saved more than their matching contributions would require, while 18% saved exactly enough to get the full match – leaving 34% of participants who either don't contribute or contribute, but not enough.

A more recent study that focused on married couples found similar results. It discovered that 24% of married couples don't claim all of their employers' matching contributions, costing the average couple in this group $682 per year.

Don't turn down free money

Let's be perfectly clear. Not taking full advantage of your employer's matching contributions is literally turning down free money. It's part of your total compensation package.

Think of it this way. If you earn $100,000 per year and your employer is willing to match 5% of your salary in contributions, and you only choose to contribute 3% of your pay, you are missing out on $2,000 in free money.

Not only that, but retirement contributions are also tax deductible. So, in this example, you'd also be entitled to an additional $2,000 tax deduction if you were to contribute enough to take full advantage of the matching contributions.

Why are some employees not taking full advantage?

One of the major culprits is also one of the most positive features of 401(k) plans -- the surge in auto-enrollment of new employees.

In 2023, the average 401(k) company match was 4.7% of compensation, according to Fidelity. However, the average default contribution rate of plans that automatically enroll participants is 4.1%.

To be sure, this represents progress, and auto-enrollment has been a net positive for making sure American workers are financially prepared for retirement. Plus, it wasn't too long ago that most plans that auto-enrolled participants did so at rates of 2% or 3%. But it means that the average person who gets auto-enrolled in a 401(k) plan isn't contributing enough to take full advantage of their employer match.

There are other reasons as well. As an example, many people feel that they simply can't afford to part with 5% or 6% of their paycheck. Others would rather save in an individual retirement account (IRA) instead. You open an IRA with a brokerage firm, and get more control over your investments, so some prefer this to a 401(k).

The long-term effects can be devastating

It isn't just about the free money you're turning down now. It's about what it means to your future. As mentioned earlier, the average married couple that doesn't get the full employer match is missing out on $682 per year.

However, consider what this means. If you're a 30-year-old married couple, and your investments compound at an 8% annualized rate, which is in-line with the historical long-term average for a balanced portfolio, that $682 you missed out on could grow to more than $10,000 by the time you're 65 years old and ready to retire. That could make a significant difference in your financial security in retirement. Now, imagine if you miss out on $682 every year.

The point is that your employer match is part of your compensation at work, and you should at a bare minimum contribute enough to your retirement plan to take full advantage. Not doing so is like refusing to cash a paycheck and could have major consequences down the road.