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Free Money for Your 401(k)

August 22, 2013

Have you ever seen one of those funny videos where a person stands on a street corner and tries to hand out $10 bills? Surprisingly, a large number of people just refuse the money and keep walking, while others stop and ask something like, "What's the catch?"

If someone offers us something for free, we become suspicious. After all, "there is no such thing as a free lunch."

But what if I told you there is a way to get far more than $10 in free money—$332,307 actually? And it is perfectly legal. You wouldn't have to work any harder. Just keep your job and it will magically appear. Most folks would tell me I am crazy. It's time to take another look.

I recently cited some disheartening statistics from a 2013 Employee Benefit Research Institute study:

  • One of the primary vehicles that workers use to save for retirement is an employer-sponsored retirement savings plan, such as a 401(k). Eighty-two percent of eligible workers (38% of all workers) say they currently participate in such a plan, and another 8% report they have money in such a plan but are not currently contributing.
  • Cost of living and day-to-day expenses head the list of reasons why workers do not contribute or contribute more, with 41% of eligible workers citing these factors.

The report also said that only 10% of those working are contributing the legal maximum to their plan. The maximum annual contribution for a 401(k) is $17,500 ($23,000 if you are over 50). For a SIMPLE 401(k), the limit is $12,000 ($14,500 over 50). Also, a lot of employers will match all or part of an employee's contribution.

I spoke with my CPA, David Kinard, about the limits, and he told me about a large company in Atlanta that will match 100% of the employee contribution up to 6% of the total salary, and 50% of the next 2% up to a maximum of 7% of the employee's salary. These rates are fairly typical for companies in that area.

Now that might sound complicated, but it's really not. To keep the math simple, consider a hypothetical employee, Bob Jones. Bob is 48 and makes $100,000 per year. Should Bob elect to put $6,000 in his 401(k), his employer will match it. Then it would also match 50% of the next 2% up to 7% of Bob's total salary. In other words, should Bob decide to put $8,000 into his 401(k), the company will contribute $7,000. Right from the start, Bob has earned 87.5% on his money. (He contributed $8,000, and his employer gave him $7,000.)

As the carnival pitchman says, "Wait, wait, there's more." The money that Bob contributes to his plan is tax deferred, meaning that his taxable income is reduced by that amount in the year he made the contribution. If Bob is in the 25% marginal tax bracket, he will reduce his current year tax bill by 25% of the $8,000 he contributed. Of the $8,000 Bob contributes, he saves $2,000 in taxes, and his employer deposits an additional $7,000 in his savings account.

Most workers are in a higher tax bracket during their peak earning years than they will be during retirement. By deferring taxable income until after they have retired, it's taxed at a lower rate. Of course, like all things government, the rules could change at any time.

Pay Yourself First and Learn to Live off the Rest

Being a member of the "If it sounds too good to be true, it probably isn't true" club, I turned to Vedran Vuk, our senior research analyst, to find out just how much free money this could mean.

So, back to Bob Jones, our fictional 48-year-old: Bob just joined a new company and anticipates working there until age 68. Bob will not move up the management ladder, but he will receive an average 2% cost of living raise annually. In addition, let's assume that the government increases the maximum contribution at the same 2% rate each year. Bob's 401(k) money is invested conservatively and earns an average of 4%. And since it's his salary that gets the match, let's assume he's filing separately in the 28% tax bracket.

  1. Over the next 20 years, how much would Bob accumulate if he just contributed 8% of his salary with his employer-matching deal?
  2. What if Bob contributed the maximum amount to his 401(k) each year?

So there it is. If Bob contributes 8% of his salary, he'll accumulate $539,459 over 20 years. But most important, $332,307 will come from matching, tax savings, and interest earned on matching funds and tax savings. If Bob goes a step further and contributes the maximum, he accumulates an additional $790,220. It is free money. He did not have to work any harder or any longer.

So what's the catch? Why would his company do this? It should come as no surprise that employers receive federal tax benefits for matching funds. Maybe they also set up their contribution programs to attract the best workers. Regardless of the motives, the money is there for the taking.

If you are not maximizing your 401(k) or Defined Benefit Plan Contribution, you might want to check with your personnel department. There may be some free money waiting for you.

On the Lighter Side

I am in beautiful Stowe, Vermont this week, home of Ben & Jerry's and a few other ice cream parlors. They all offer ice cream mixed with Vermont maple syrup—quite delicious! Even the folks who appear fit and healthy here seem to enjoy their ice cream cones. I haven't quite figured out how that works.

I'm spending the week polishing up America's Broken Promise: Strategies for a Retirement Worth Living, our free online event. Our team is excited to present planning tools and new portfolio ideas helpful to everyone, regardless of age. Remember, the price to attend is ideal: $0.00!

And finally…

My friend Dennis A. passed along a few church bulletin bloopers:

  • The sermon this morning: 'Jesus Walks on the Water.' The sermon tonight: 'Searching for Jesus.'
  • Ladies, don't forget the rummage sale. It's a chance to get rid of those things not worth keeping around the house. Bring your husbands.
  • Irving Benson and Jessie Carter were married on October 24 in the church. So ends a friendship that began in their school days.
  • Please place your donation in the envelope along with the deceased person you want remembered.
  • The ladies of the church have cast off clothing of every kind. They may be seen in the basement on Friday afternoon.

Until next week…

 
 

About the Author

Over the course of his career, Dennis Miller has consulted with many Fortune 500 companies, training hundreds of executives to effectively communicate the value of their company's products to their customers. Among his many multi-national clients are: GE, Mobil, Shell, Schlumberger, HP, IBM, Corning Glass, Eastman Kodak, AC Nielsen, and Johns-Manville.

An active international lecturer for 40 years, Dennis wrote several books on sales and sales management. He was a contributor to... read more