Saving and investing wisely is not an easy achievement. How much do
you need to save for retirement? Where should you put your money?
There are thousands of financial advisors who offer differing
opinions on these matters. But if there is one utterly clear maxim
of saving for retirement it's this: contribute at least enough money
to your 401(k) to maximize your employer's contribution.
Much to my shock and dismay, 39% of 401(k) participants don't follow
this totally noncontroversial advice, according to a new study by
Financial Engines, via the NY Times Bucks blog. That's crazy. Here's
why maxing out your 401(k) is the biggest financial no-brainer
you'll ever encounter.
When your company promises to match some contribution to a 401(k),
it's like giving you a raise. Refusing the match is like telling
your company that you don't want extra money. Imagine an example
where you make $1,000 per paycheck. Now imagine if your company
agrees to match 50 cents per dollar up to 6% of your 401(k)
contribution per paycheck. That means you can put up to $60 per
paycheck into your 401(k) and your company will also contribute $30.
Did you see what just happened? You got a 3% raise. Sure, you had to
contribute $60 of your gross income as well, but this money just
becomes savings -- something you will surely need some day anyway.
Unless you are one of the few people who believe Social Security
alone will be sufficient to allow for a pleasant, comfortable
retirement at a reasonable age.
Moreover, that $60 you contribute doesn't reduce your take home pay
by 6%, because it's taken pre-tax. For example, let's say after all
taxes are taken, your income would normally have been 30% lower. If
you didn't contribute to your 401(k), your after-tax income would be
$700. If you contribute $60 pre-tax, however, your after-tax income
is $658 -- only $42 less, instead of $60. This is the second reason
why it's so great to contribute to a 401(k): you can delay taxes on
that money, so you won't feel like you're saving as much as you
Let's reflect on this scenario where you contribute to your 401(k)
as described above. Your after-tax income declines by $42, but you
save $90. This is one of the best deals you'll ever get, and it's
virtually impossible to beat.
Let's consider poor reasons not to contribute enough to receive your
full employer match:
I Want More Freedom Investing
Maybe you don't like your employer's 401(k) plan. You hate mutual
funds. You think you can do better on Scottrade. Good luck with
that. In the example above, imagine if you decided to shun your
401(k) and invest $42 (the difference in after-tax income) from each
paycheck yourself instead. You would need an investment that would
more than double your money -- even if you saved your 401(k) as pure
cash. The return would have to be 114% to get $90.
I Worry About Losing Money in the
Investing is hard, so this is a fair point. But you would have to do
incredibly poorly to lose more than you gain from your 401(k) match.
For that $90 savings to decline below your $42 contribution, it
would have to decline by more than 53%. Even from the Dow's peak
prior to the financial crisis to the bottom it hit in early 2009,
the market lost less than 50% -- and that's about as bad as it gets.
Moreover, you can generally diversify your 401(k) holdings to
include stocks, bonds, and cash.
I Can't Afford to Contribute That
Saving isn't a financial constraint: it's a choice. Unless you're
living very near the poverty line, then it's possible to find ways
to cut expenses. And slicing 4% off your take home pay won't require
most people to dramatically change their lifestyle. Go out to dinner
less often or wait until a movie comes out on video to see it. Move
a few miles further out of town to get a cheaper rent. Remember, you
aren't actually lowering your income by contributing to a 401(k);
you just don't spend as much of your money immediately. In fact,
you're actually implicitly increasing your income by maximizing your
I Don't Want My Savings Tied Up
If you need to get at your 401(k) money for some reason before you
retire, you will get hit with a penalty and be forced to pay taxes
on it immediately. That means the money is essentially tied up. But
this isn't a good reason to fail to contribute up to your full
First, some 401(k) plans allow leeway for when a true emergency
hits, where the penalty won't apply. Second, even if a penalty does
apply, will it really be greater than your employer match? In the
example above, a 10% penalty tax would apply beyond the usual income
tax that you would have paid anyway on the income that you
contributed. For the example, that penalty would be $9, and you
would also need to pay something like $9 in taxes on the employer's
contribution. But your employer contributed $30. So again, even if
you try to get at your money early, you're still $12 ahead by
maximizing your employer contribution.
If you don't already contribute enough to your 401(k) to maximize
your employer match, then you should. It's easily the smartest,
easiest financial decision you'll ever make. You may want to
ultimately save more than that through other methods, but this is
the bare minimum saving that you should do.
Daniel Indiviglio is a staff editor
at TheAtlantic.com, where he writes about credit markets,
regulation, monetary & fiscal policy, taxes, banking, trade,
emerging markets and technology. Prior to joining The Atlantic, he
wrote for Forbes. He also worked as an investment banker and a
Gosh, I'm rich!
Silver in the Hair
Gold in the Teeth
Rare Stones in the Kidneys
Sugar in the Blood.
Lead in the Ass
Iron in the Arteries
an inexhaustible supply of Natural Gas.
I never thought I'd
accumulate such wealth.