One-Third of Americans Are Making a Significant 401(k) Mistake – Are You Guilty?

One-Third of Americans Are Making a Significant 401(k) Mistake – Are You Guilty?

One-Third of Americans Are Making a Significant 401(k) Mistake – Are You Guilty?

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The typical employer with a 401(k) plan will contribute between 3% and 6% of an employee’s compensation on behalf of its employees. But to benefit from it, employees must contribute money themselves, this is called matching contributions.

According to several sources, far too many Americans are leaving money on the table by not taking advantage of their employer matching contributions. A 2021 survey by personal finance site MagnifyMoney found that 17% of people with access to an employer-sponsored retirement plan don’t contribute at all, and of those who do, 12% don’t contribute enough to obtain the full consideration for their business. contributions.

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Additionally, a Vanguard study found that 48% of 401(k) program participants saved more than their matching contributions would require, while 18% saved exactly enough to get the full match – leaving 34% of participants who do not contribute or who contribute, but not enough.

A more recent study of married couples found similar results. The study found that 24 percent of married couples don’t claim their full employer matching contributions, costing the couple in this group an average of $682 per year.

Don’t refuse free money

Let’s be perfectly clear. Not taking full advantage of your employer’s matching contributions is literally turning down free money. This is part of your overall compensation.

Think about it this way. If you earn $100,000 a year and your employer is willing to match 5% of your salary in contributions, and you choose to only contribute 3% of your salary, you’re missing out on $2,000 of free money.

Additionally, pension contributions are also tax deductible. So in this example, you would also be eligible for an additional $2,000 tax deduction if you contribute enough to take full advantage of the matching contributions.

Why do some employees not take full advantage of it?

A major culprit is also one of the most positive aspects of 401(k) plans: increased automatic enrollment of new employees.

In 2023, the average company 401(k) match was 4.7% of compensation, according to Fidelity. However, the average default contribution rate for plans that automatically enroll participants is 4.1%.

Certainly, this represents progress, and automatic enrollment has been a net benefit in ensuring that American workers are financially prepared for retirement. Additionally, it wasn’t that long ago that most plans that participants automatically enrolled in did so at rates of 2% or 3%. But that means the average person who automatically enrolls in a 401(k) plan isn’t contributing enough to take full advantage of their employer match.

There are other reasons too. For example, many people feel that they simply cannot afford to part with 5 or 6% of their salary. Others prefer to save in an individual retirement account (IRA) instead. You open an IRA with a brokerage firm and gain more control over your investments, which is why some prefer this to a 401(k).

Long-term effects can be devastating

It’s not just the free money you’re turning down now. It’s about what that means for your future. As mentioned previously, the average married couple who does not receive full employer matching loses $682 per year.

However, think about what that means. If you’re a 30-year-old married couple and your investments compound at an annualized rate of 8%, which is consistent with the long-term historical average for a balanced portfolio, the $682 you missed could add up to more of $10,000 by the time you are 65 and ready to retire. This could make a significant difference to your financial security in retirement. Now imagine if you miss out on $682 each year.

The fact is that your employer’s match is part of your compensation at work and you should at the bare minimum contribute enough to your retirement plan to take full advantage of it. Failure to do so is tantamount to refusing to collect a salary and could have major long-term consequences.

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Up to a third of Americans make this huge 401(k) mistake. Are you one of them? was originally published by The Motley Fool

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