One of the first things I learned in finance was TANSTAAFL: There Ain’t No Such Thing As A Free Lunch. 401(k) matching is about as close to a free lunch as it gets.
When you work for an employer that offers a 401(k) plan, they’ll generally offer 401(k) matching and the amount of the match varies by employer. Some companies may match dollar-for-dollar up to 5% of your pay. In other words, if you put $1,000 into your 401(k), the employer will contribute an additional $1,000 on your behalf. Most companies have become a bit more conservative and will more likely match something like 50% up to 4% of your pay. So, you put in $1,000, the employer will contribute $500.
Take advantage of 401(k) matching! Most investments are considered “good” if you can double your money within seven years. This is an immediate 50%-100% return on an investment! Indeed, taking advantage of matching would be a very frugal thing to do!
There are a couple other important elements you should understand. First, the matching limit. In our last example, if you’re making $100,000/yr and 4% is the matching limit then the employer will match up to $4,000 of your contributions. That is, you contribute $4,000 and the employer contributes $2,000 (50% of your contribution). If you contribute any more than $4,000 the employer will still only contribute $2,000 because that’s the max they’re willing to contribute for that year.
Second, be aware of vesting. Vesting may sound like a fancy term but the concept is really pretty simple. Your employer can set up a vesting schedule for their contributions. The schedule can vary widely, but one example might be a five year vesting schedule. This means if you leave after 2 1/2 years, you get to keep 1/2 of the employer’s contributions (20% for each year). In other words, even though your employer may have contributed $10,000 over the past 2 1/2 years, you really only get to keep $5,000 of their contributions if you leave the company at that moment. After 5 years, you get to keep all previous and future employer contributions. It’s one way companies tempt you into sticking around awhile. Note that your contributions are always yours. Vesting is only tied to the employer’s contributions.
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