Plenty of jobs come with a retirement plan, usually a 401(k), and plenty of those plans come with a match: you put part of your paycheck in, and your employer adds more. The match is the closest thing to free money you’ll find at work, and a lot of people in their twenties leave some of it on the table.
(Employer deposits into a health savings account also count as free money. I’ll allow it. Everything else that calls itself free money is a credit card offer.)
How a match works
A common formula is 100% of the first 3% of pay you contribute, plus 50% of the next 2%. If you earn $55,000, a year looks like this:
- You put in 2% ($1,100). Your employer adds $1,100.
- You put in 3% ($1,650). Your employer adds $1,650.
- You put in 5% ($2,750). Your employer adds $2,200.
- You put in 8% ($4,400). Your employer still adds $2,200.
The match tops out at 5%. Below that, every percent you skip is money your employer was ready to pay you and didn’t. At 2% in that example, you’re turning down $1,100 a year.
Your plan’s formula may be different. It’s in the plan’s summary document, usually called the summary plan description, or you can ask HR in so many words: what do I need to contribute to get the full match?
What it costs you
Less than it looks. In a traditional 401(k), your contribution comes out before income tax. A 5% contribution on $55,000 is about $106 a paycheck if you’re paid every two weeks, but your take-home pay drops by less than that, often somewhere around $85 to $95, depending on your tax bracket and your state.
If your plan offers a Roth 401(k), you pay the tax now instead of in retirement, so your paycheck drops by the full amount. Which is better depends on whether your tax rate is lower now than it will be later, and nobody knows that for sure. Early in a career, when income is lower, a lot of people lean Roth. Either way, you get the match.
The fine print
- Vesting. The money you put in is always yours. The match may not be yours yet. Some plans vest it right away. Others use a schedule, like nothing until three years and then all of it, or 20% a year. Federal law caps how long they can make you wait. If you’re thinking about leaving, check your vesting date first.
- Waiting periods. Some employers don’t start matching until you’ve been there a few months, or a year. Enroll anyway, so you’re set up when it starts.
- Auto-enrollment. Many plans now sign you up automatically, often at 3%, which may be below what it takes to get the full match. Check the number. Nobody picked it with you in mind.
- Where the money goes. If you don’t choose investments, contributions usually land in a default fund, often a target-date fund. That’s a reasonable starting place for many people. Check its fees, listed as an expense ratio. Markets go down as well as up, and nothing here is a promise about what your balance will do.
If you have debt
If you’re carrying a credit card balance at 25% interest, the usual advice is still to contribute enough to get the full match, then send every spare dollar after that to the card. Once vested, the match adds between 50 cents and a dollar for each dollar you put in, the day it’s deposited, and paying down a card doesn’t save you that much. Past the match, the card comes first. Your situation may differ, especially if you’re behind on payments or have nothing set aside, so keep a few hundred dollars in the bank for the next surprise, or it ends up on the card.
No 401(k) at work?
You can open an IRA at most brokerages in an afternoon. There’s no match, but you get the same choice between traditional and Roth, with income limits on the Roth version. It’s worth doing even with a small monthly amount.
This week’s homework takes five minutes. Log in to your plan, find your contribution rate and your employer’s formula, and check that the first number is high enough to collect all of the second.