How Does 401(k) Matching Work?
August 31, 2020
By Rahul Iyer
Do you like free money? Who doesn’t? That’s what your employer 401K match is – free money. If you don’t contribute to your 401K, you give up this benefit and decrease your potential retirement earnings.
What is a 401K Match?
Employers who offer a 401K often include a 401K match where they match a portion of your contributions. Each employer differs, but you may expect an average of a 3 – 5 percent match.
Let’s say, for example, you make $75,000 per year and your employer offers a 5 percent match. They will match contributions of up to $3,750 or 5 percent of $75,000. They only match what you contribute, though. If you don’t put anything into your 401K, you miss out on the match.
In addition to the percentage match, each employer differs in how much of your contribution they’ll match. Most employers offer either a 100 percent or 50 percent match. Using the $3,750 example, you’d receive $3,750 or $1,875 respectively.
The Maximum Contribution
Your employer won’t match up to your maximum allowed contributions, but that doesn’t mean you shouldn’t contribute.
At the very least, contribute the amount your employer will match. It’s like giving up free money if you don’t. Using the $75,000 a year example, at 100 percent match, you’d get $3,750 in addition to your own $3,750. That’s like starting your retirement account with $7,500 rather than $3,750.
The more money you have to compound, the more money you’ll have for retirement without worrying about working harder or more to save more money.
Keep in mind, you can contribute up to $19,500 (in 2020) in your 401K. Just because your employer matches up to 5 percent, for example, doesn’t mean you can’t contribute more – you can contribute as much as you can afford.
Your Earnings are Tax-Deferred
You contribute to your 401K before taxes. In other words, you lower your current tax liability. You also don’t pay taxes on the employer match until you withdraw the funds. If you wait until you’re 59 ½ to withdraw from the account, you’ll pay ordinary taxes based on your current tax bracket.
If you withdraw early, you’ll pay a 10 percent penalty fee plus the taxes, so keep that in mind. The money should be earmarked for retirement unless you have a financial emergency.
If you’re in a lower tax bracket when you retire, you’ll pay fewer taxes on the same money. Work with your tax advisor to withdraw only the funds that keep you within the lower tax bracket, so you keep more of your employer’s contributions.
Should you Contribute to your 401K?
At the very least, contribute as much as your employer will match. If you don’t take it, you decrease your employee benefits and/or will need to make up for that amount by contributing your own funds to prepare yourself for retirement.
Take advantage of your retirement benefits from your employer and enjoy the higher level of retirement funds to set you off on the right foot.
Struggling to get all your employer match money? Lendtable can help you with this, too.