401(k) and Employer Matching
As a CERTIFIED FINANCIAL PLANNER™ and a financial coach, I know that retirement is often on people's minds. For some individuals retirement seems like a long time away and for others retirement is right around the corner. Bottom line is everyone is thinking about retirement, even those who love their careers. Often the answer to the question, "When do I get to retire?" Depends wholly on how well the person asking it planned for retirement. Working hard is essential, and it's a noble thing, but working smart is even better - so make your money work smart towards retirement.
However, there's an all-too-common issue. People come into retirement age but don't have any plans or savings that they've put back to actually retire. This leaves people with precious few options, and often, many people opt to continue working well into their old age so they can save enough to take a few years off. But that's not what any of us want! We want to retire while we're still happy and healthy so we can enjoy our golden years with our family and friends - not work. The only way to ensure that this unfortunate circumstance stops being a reality for many people is through education. And that's part of the reason for today's blog post. Today we're talking about 401(k)'s, but more specifically - Employer Matching 401(k)'s. This is a concept that many (even those who have one) don't understand, so it's important to dig into the nuts and bolts and make sure it's as crystal clear as possible.
Okay… I know I've written about 401(k) 's here or there in posts where they're relevant. My avid readers will have to forgive me, but because 401(k) 's are so prevalent in this article, I'm going to give (another) brief explanation about what they are and how they generally work. While the specifics of your 401(k) plan may vary depending on your employer, what typically stays the same is how they're taxed. With a 401(k), you'll be allowed to contribute $19,500 annually, which won't be taxed until it's withdrawn from your account.
A 401(k) is a retirement account that's customarily offered to employees by their employers. This is a benefit that is non-mandatory, so your employer may or may not provide them. One of the great parts about 401(k) 's is that they have certain tax advantages. These advantages generally depend on what type of 401(k) you have. While there are a few different types of 401(k) 's, the most common two are Traditional 401(k)'s, which allow you to contribute tax-free and pay taxes on your earned money when you withdraw it in retirement. This allows the account to maximize the investment earning potential of your pre-tax money by compounding interest. The second type, a Roth 401(k)'s, will enable you to contribute after tax dollars. After which, you'll no longer owe taxes on that investment, even when you go to withdraw money in retirement.
Both primary types of 401(k) plans are great, but both also have their gives and takes. The main thing to remember is that with Traditional, you pay taxes after, and with Roth, you pay them before contributing. The issue that arises when people ask, "Which is better" depends on your situation and your speculation. So there you have it… a 401(k) is essentially a type of retirement account with tax advantages that depend on the structure of your account.
When people talk about their 401(k)'s, they'll talk about their employers matching or not matching. What is this? In a nutshell... employer matching is free money given to you by your employer for investing in yourself and your financial future. If your employer matches 401(k) contributions, it means that they'll essentially contribute the same amount towards your 401(k) as you do. 401(k) matching is a fantastic employee benefit, but it often comes with stipulations and limitations on how much your employer matches. For example, an employer may cut off matching 401(k) contributions at a specific dollar amount or percentage of salary. The exact amount could vary and be based on federal legislation or their personal contribution limitation.
Dollar for Dollar Matching Vs. Partial Matching
More terms that you need to know. Luckily, these are pretty straightforward as long as you keep them straight in your head. We'll start with Dollar for Dollar matching because it's simple and just about what it sounds like. Dollar for Dollar matching is when an employer is willing to match 100% of each dollar you contribute to your 401(k). Like all matching contributions, Dollar for Dollar has a cut-off point, which could be determined by a dollar amount or a salary percentage depending on your employer's policies.
Next is Partial Matching, which is an employer matching a percentage of what you contribute to your 401(k). With Partial Matching, your employer will typically match 50% of your contributions up to a portion of your salary. For example, if you contributed $1,000 and your salary was $30,000, and your employer matched 50% up to 3% of your salary, your employer would match your contribution at $500 up to $900.
With Dollar for Dollar or partial matching, your employer might set the overall limit on contributions as a percentage of your salary. As an individual employee, you're also limited to contributing$19,500 to your personal 401(k). However, this doesn't count towards employer contributions. According to Ellevest, "there is a limit for employee and employer contributions combined: Either 100% of your salary or $57,000 ($63,500 if you're over 50), whichever comes first."
Do All Employers Match 401(k) Contributions?
No, unfortunately, all employers do not match 401(k) contributions. In fact, not all employers even have 401(k) plans available at all. However, there's sort of a strange twilight zone between employers matching and employers not even having a 401(k) option. That twilight zone is called non-matching contributions. Non-matching contributions are essentially when an employer contributes to your 401(k) or a profit sharing account when an incentive or goal is met. This non-matching contribution is totally independent of an employee contribution. For example, if you worked for me and I gave you a non-matching contribution of $4,000 or 10% of your $40,000 salary because our business exceeded our profit goals, You would be required to contribute $0. However, you could absolutely still contribute up to $19,500 to your 401(k) account if you wanted to.
Employers who make non-matching contributions to employee 401(k)'s also set contribution limits in the form of percentages or dollar amounts (or both). A contribution cap may be set at 10% of an employee's salary or a specific dollar amount, like $10,000 (for example).
401(k) Vesting Schedules
Vesting schedules are one of the more essential terms that you should understand if you have an employer-matching 401(k) contributions. This is because a vesting schedule determines how much of your employer's contribution you're entitled to before you're fully vested. Being vested in this sense essentially means that you've been with your company for a certain amount of time. Larger employers will typically vest an employee after a few years, while smaller companies (who are on stricter budgets) will not fully vest an employee for up to five or six years.
Some employers require you to become fully vested before you're entitled to any of your employer's contributions. In contrast, others operate on a schedule that releases a percentage of your employer's contribution to your own after time-marked increments. For example, you could have an employer set aside money to match your 401(k) contributions but not release that money until you're fully vested after 3 years. Differently, you could have an employer that released 25% of their contribution to your 401(k) each year for four years, after which you no longer have to wait for their contributions.
Something important to keep in mind with vested schedules is that while your employer is holding on to their contribution towards your 401(k), the money that you contribute is wholly yours when paid in. So, if you're not going to be vested for three years, have a dollar-for-dollar match, and donate $1,000 each year, you'll have $3,000 in your 401(k). After three years, your employer will release their match of $3,000, which will give you a total of $6,000 (your $3,000 plus their $3,000).
What's a "Good Match" for Matching Your 401(k)?
Because many people don't get 401(k) matching in any fashion, I'm tempted to say that any 401(k) match is good. After all, it's free money to the extent that you get for saving for retirement. However, the fact is that the majority of employers who match will do 50% of your contribution up to 6% of your salary, according to Investopedia. So anything comparable or better than that, I'd say, is clearly a good matching 401(k) plan. Ultimately, a matching 401(k) plan is a good thing to have either way.
I don't want you to skip saving into your 401(k) if employer does not match! There are still potential benefits to saving in your retirement account, such as reduced taxable income! There may also be a benefit to funding your 401(k) if you are working toward paying off student loan debt and Public Service Loan Forgiveness! Contact me, and let me walk you through the process!
401(k)'s, Taxes, and matching
With a 401(k), you're looking at a tax-advantaged account, which is fantastic. In a traditional 401(k), your income is reduced, and you don't have to pay taxes on the money put into your 401(k) that year. However, you obviously have to pay taxes for those earnings at some point, usually when the money is withdrawn after retirement. But this is where many people get lost… what about the employer contribution side of the money going into your 401(k)? Do you have to pay taxes on that? The answer is quite simply, yes… but not until it's withdrawn. This is because the money that your employer contributes to your 401(k) doesn't count as income, so there's not a need to pay any taxes on it. However, once it's withdrawn from your 401(k), it will count as income and will need to be taxed.
How Much of My Employer's Match Should I Take Advantage of?
This is a great question that I get all of the time. The answer is a little more complex than you might imagine, and there are a few factors that need to be considered beforehand. First, what's your personal financial situation like? While investing money is a fantastic move that you can make for your future - it can't be done at the extent of the present. In other words, it doesn't do you much good to invest if you can't afford to live right now. You need to also be able to work on your emergency fund, savings account, pay your bills, and pay for food and rent.
Second, what's your employer's match? How good of a deal is it? If your employer matches at a high level or percentage, you may wish to fund your 401(k) more heavily than if they aren't. However, either way, you need to be saving towards retirement early and often.
Third, have you talked to your financial planner? No one knows you and your financial situation like your financial planner. While you could come up with a ballpark number, your financial planner can crunch the numbers and really come up with the amount that makes the most sense for you to contribute. They could do this by comparing your bills, income, assets, and liabilities and taking a good look at your employer's 401(k) matching plan.
A CERTIFIED FINANCIAL PLANNER™ Can Help YouUnderstand Your 401k Options
If you're confused or worried about your 401(k) or how your employer's matching plan compares to others in your area, please, feel free to call or email to schedule an appointment with me. As a CERTIFIED FINANCIAL PLANNER™, financial coach, college planner, and student loan advisor, I bring the full spectrum of financial know-how to the table. I can work with you on anything from coming up with the perfect 401(k) contribution number to paying off your student debt. Together we can create a financial plan that helps you become debt-free, make a savings security blanket, and put your money to work for you!
Until next time...this is Melissa Making Cents!
Melissa Anne Cox, CERTIFIED FINANCIAL PLANNER™, is also a College Planning and Student Loan Advisor and Financial Coach in Dallas, Texas.