As many as a third of Americans make this huge 401(k) mistake. Are you one of them?

By | March 26, 2024

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The typical employer with a 401(k) plan will contribute between 3% and 6% of an employee’s compensation on behalf of his or her employees. But to benefit from this, employees must contribute money themselves. We call this 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 from 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 the income from their business. contributions.

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Additionally, a Vanguard study found that 48% of 401(k) participants saved more than their matching contributions needed, while 18% saved just enough to get the full match—leaving 34% of participants who either didn’t contributes or does not contribute. but not enough.

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

Don’t turn down free money

Let’s be perfectly clear. If you don’t take full advantage of your employer’s matching contributions, you are literally turning down free money. It is part of your total compensation package.

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

Not only that, but pension contributions are also tax deductible. So in this example, you would also be entitled to an additional tax deduction of €2,000 if you contributed enough to fully benefit from the corresponding contributions.

Why are some employees not taking full advantage of the benefits?

One of the biggest culprits is also one of the most positive features of 401(k) plans: the increase in automatic enrollment of new employees.

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

To be fair, this represents progress, and auto-enrollment has, on balance, ensured that American workers are financially prepared for retirement. Additionally, it wasn’t long ago that most plans that automatically enrolled participants did so at a rate of 2% or 3%. But it means that the average person who automatically enrolls in a 401(k) plan isn’t contributing enough to take full advantage of their employer-employer match.

There are other reasons too. For example, many people believe that they simply cannot afford to part with 5% or 6% of their salary. Others prefer to save in an individual retirement account (IRA). You open an IRA with a brokerage firm and gain more control over your investments, so some prefer this to a 401(k).

The long-term effects can be devastating

It’s not just about the free money you’re turning down now. It’s about what it means for your future. As previously mentioned, the average married couple who does not receive the full employer match misses out on €682 per year.

However, consider what this means. If you are a 30-year-old married couple and your annualized investments are 8%, which is in line with the long-term historical average for a balanced portfolio, the $682 missed could add up to more than $10,000 by the time you are 65 years old and are ready to retire. That can make a significant difference in your financial security after retirement. Now imagine missing out on €682 each year.

The point is that your employer match is part of your compensation at work, and so should you at an absolute minimum contribute enough to your retirement plan to take full advantage of it. Failure to do so is equivalent to refusing to collect a paycheck, which can have major consequences down the road.

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As many as a third of Americans make this huge 401(k) mistake. Are you one of them? was originally published by The Motley Fool

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