I’m Getting a 401(k) Match! Here’s What That Means.

I get a biweekly paycheck for my work every other Friday; that includes tomorrow, July 1^st. My paycheck after that one (on the 15^th) will be thousands of dollars more than I normally get. Specifically, because that’s when my company will officially begin offering me a 401(k) match!

This will be the first time I’ll be eligible for a 401(k) match and I’m stoked. This basically means free money for me and can be considered an automatic return for part of my investments. No longer will my contributions be the only contributions into my account; my employer will also be putting money in. Here’s the breakdown of what that means.

The 401(k) Match Basics

As I’ve written before, a 401(k) is a great investment vehicle where you don’t pay tax on the amount of money you contribute. If you manage to put in as much as the law allows (which, as of 2022, is $20,500) then you no longer have to pay tax on thousands of dollars. It’s done this way to incentivize you saving for your retirement (as that’d equal less dependency on social services in your old age). While it’s possible to take money out of it for certain reasons – like using the money to help buy a house – you usually have to wait until you’re 59-and-a-half years old to take money out without paying extra fees.

That being said, there are strategies you can take to access your funds early. They make investing with a 401(k) the ideal choice for your future wealth. Once you add a 401(k) match to the mix, it only sweetens the pot further.

A 401(k) match means your employer agrees to put in a certain amount of money into your 401(k) after you contribute some of your paycheck. Some companies will match more than others. The median match is 4%, with an average match between 3% and 6%. Whatever the percentage, that’s how much of your salary you’ll get placed into your 401(k).

The 401(k) Match Numbers

I’ve got some examples to explain what these percentages mean. Let’s say your employer offers a 4% match. This percentage means it will match however much you add to your 401(k) that’s 4% of your salary. If your salary is $50,000, they will match 4% of that $50,000. This translates to adding an extra $2,000 on top of your contributions, if you put that much into your 401(k). Making $100,000? They will match $4,000. If I got this 4% match when I was making $30,000 a year, I would have seen an extra $1,200 getting added since 4% of 30 grand is $1,200.

Some companies offer half-matches that looks confusing; it’s often along the lines of “we match 100% on the first 3% of employee contributions and 50% on the next 5%.” This lovely bit of legalese and multiple uses of the “%” sign are actually them trying to tell you “hey, we’re squeezing MORE pennies out of the stingy executive team to get you richer”:

“100% match on the first 3%” means that they will contribute 3% of your salary if you also contribute 3% of your salary. In this case, that 3% is $1,500. As long as you contribute $1,500 to your 401(k) they will contribute another $1,500 on your behalf, which is $3,000.

“50% match on the next 5%” means that, if you contribute 5% of your salary after you’ve already submitted 3%, they will contribute half of whatever else you put in here. 5% of $50,000 is $2,500. If you contribute that much, they will also contribute another $1,250. This applies to any amount up to that $2,500 you put in – if you contribute an extra $1,000 (after your initial $1,500) then your employer will contribute another $500. Put in $500 more? Employer contributes $250.

The 401(k) Match At Its Limits

As of 2022, the contribution limits for 401(k)s are set at $20,500*. Let’s say you plan to reach that limit on your $50k salary – which is super impressive, by the way. If you do so, here’s how much money you’ll end up with in contributions in different scenarios.

Scenario 1, Employer offers a 100% match on 4%: Out of the $20,500 you contribute, you get an extra $2,000 in contributions for a total yearly contribution of $22,500.

Scenario 2, Employer offers 100% on first 3% then 50% on the next 5%: Out of the $20,500 you contribute, you get an extra $2,750 in contributions. That is a total yearly contribution of $23,250.

What makes this even sexier is the fact that compound interest will be boosted by these extra matches. Suddenly you’ll see your returns accelerating further, because those 401(k) matches will earn money right alongside your other investments. That extra $2,000 this year may very well translate into an extra tens of thousands down the pike.

Guaranteed Investment Returns With That Phat Match

Investing 101 teaches there is no such thing as a guaranteed return. That’s true with money truly invested – even relatively tame downturns like the current bear market will still see investments lose significant value.

This is what makes a 401(k) match different. The amount you get from your match isn’t dependent on the stock market. It’s only dependent on how much money you put in, according to the company’s 401(k) rules. By considering a match as part of your investment returns, you’ll see a much higher investment return right off the bat.

Say you’re making $50,000, your company’s a Scenario 1 from the last section, and you only contribute enough to get the full match of $2,000. That means your $2,000 automatically gets another $2,000 put in, for a total of $4,000. That, my friend, is an automatic 100% return on your $2,000. If the market returns 0% that year, you’d have still doubled your money from doing nothing. This is an even easier route to investing than the index fund strategy is, as you don’t even have to actually invest the money (but you should!)

In Scenario 2, contributing enough to take advantage of all the matching means you see an automatic return of over 68%. With 10% as the standard, you’re making nearly seven times that from the 401(k) match alone.

If you’re only contributing enough to reach the contribution limits, your numbers are still impressive. In Scenario 1, your match gives you an automatic return of 9.75%. In Scenario 2, your match gives you an automatic return of 13.4%. That is more than what 4 out of every 5 mutual funds make. You are the king, queen, remarried empress, or otherwise ungendered sovereign ruler of wealth building with that kind of EOY return.

Should You Contribute to Get a 401(k) Match?

So with all of these perks, you still may have a financial situation that makes 401(k) contributions the inferior decision. Such situations are few and far between, given all the benefits of a 401(k) match. Ask yourself the following questions, and reconsider how much you should contribute to your 401(k) if the answer is “yes”:

• Will you definitely need that money soon? It’ll take time to access that money, so it can’t be used for next week’s groceries or next month’s rent.
• Do you not care about getting the tax deduction? Maybe you have a very specific tax situation to navigate that’s beyond the scope of this writing. In that case, it’s best to talk with the professionals on this one.
• Do you have high-interest debt? While using tax-advantaged accounts is baller, your gains may be wiped out if you have to pay back loans with interest rates over 15%.
• Does your 401(k) have fees too high to bother with? Excessive 401(k) fees are real. Don’t bother if the fees are predatory and unreasonable.
• Are you without an emergency fund? Any number of things can happen to result in you being unable to work. Build at least a small cash cushion in case the worst is to happen.
• Does your company’s vesting schedule make it suboptimal? Hat tip to Emily for this point – some employers make you wait some time before their employer match is fully “vested” (i.e. fully your funds free and clear). Understanding your vesting schedule is very important to know if you’re going to job hop down the line.

If you answered “no” to the above, congratulations! Snatching that 401(k) match and running for the hills is the best thing you can do! This is especially true if you’re in your 20s and you’re investing the money anyway. Having a plan now will lead to massive riches later on, which will only be accelerated with a 401(k) match.

*It increases a little more once you hit your 50th birthday, which should be a long time off for most readers.

Cover image credit: Kari Shea via Unsplash