25 July 2011

Don't short change your 401(k)!

401(k) retirement savings plans offer the best chance that many folks have to contribute towards their own retirement. Therefore it is critical that you contribute as much as you possibly can to your 401(k). How much is that? Well, of course, that answer is the same as the answer to most questions about personal finance: It depends.

Here is how most plans work: You, the employee, sign up to have a specified percentage of your pre-tax earnings put into a special account that will be invested and grow so that you can afford to retire someday. This percentage can be anywhere from 1% to 10% in most cases, although Doc has seen some plans that allow for a 20% contribution.

There is a maximum limit for most individuals of $16,500 for 2011 ($22,000 if you are over 50). This means that if you earn more than $165,000, you might have to do some calculating. However, if you are earning that much, you can probably afford the services of a fee-only personal financial planner to help you with this and other things.

The true beauty of the 401(k) plan is that, in most cases, your employer also makes a contribution on your behalf. Typically, an employer will contribute 50 cents for each employee dollar contributed up to 6% of the employee’s salary. Again, your plan may vary. Check with your employer and your HR department. So, if you earn $40,000 per year and have a typical plan, you can contribute $4,000 (10% of salary) to your 401(k) and your employer will contribute $1,200 (50% of 6% of $40,000).

So what happens to that $1,200 if you do not contribute at least the $2,400 per year to claim your stake in it? I don’t know. One thing is for sure, though: you will never see a penny of it. If you do not contribute enough to your own retirement plan to earn the match from your employer, then that money is still your employer’s, not yours. This is part of your overall compensation, money that you are able to earn, but if you do not contribute your share, than your employer will keep those funds for his/hers/its own purposes. Got that? It’s important. It is your compensation and it is up to you to claim it.

If you took a look at the Wall Street Journal linked above, you saw that a lot of people do not contribute as much as they can to their 401(k) accounts, thus missing out on a significant benefit. Do not make this mistake. And don’t be harsh on your employer; they have to look out for their best interests, too. Since 2006, most employers have taken advantage of a law that says they can automatically enroll employees in a 401(k) plan. Typically (a frequently used word when describing 401(k) plans), this number is 3%. So a lot of people come to their first day of work, sign a bunch of papers and save 3% of their pre-tax earnings and call it good. The Employee Benefit Research Institute has found that people are more likely to go with the 3% default contribution than to contribute as much as they need, or even as much as required to claim their full amount of compensation.

But you can do better. First, find out how much your employer contributes. Then, contact your HR department and make sure that you are contributing AT LEAST enough to maximize the employer’s matching contribution and take full advantage of the compensation available to you. It is your money, but you will not have access to it until you take the action necessary to claim it.

For public employees who have 403(b) plans, this is one of the ways in which most of us are not similar to our 401(k) holding counterparts. However, your employer may offer additional ways to save pre-tax earnings, and you should definitely look into those.

Once more, it is your money. Get your hands on it. 

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