It is no secret that when Millennials retire social security is either going to be entirely gone, or drastically different than it is today. This means individual retirement planning is more important than it has been for previous generations. Most companies offer a 401k as one of their benefits. In essence, a 401k plan is a retirement contribution plan where employees can make take a portion from their paycheck and put it in a retirement account on a pre-tax basis. I’m always surprised when I talk to people about their retirement plan, and they don’t understand some of the basic features of their 401k or 403b.
The biggest mistake millennials make when contributing to their 401k plan is NOT TAKING ADVANTAGE OF THEIR EMPLOYEE MATCH PROGRAM. The overwhelming majority of companies offer to match a certain percentage of what you put in. As of 2013, the most common matching program was 100% match for the first 6% you contribute. Meaning if you opt to have 6% of your pay into your 401k plan, the company will match that and add an additional 6% to your plan. Even if the company you work for is not as generous in this realm, another common standard is 50% match for the first 6% you contribute.
If you contribute less than what your plan offers you are simply leaving money on the table. For example, let’s say you make $24,000 a year and your employer offers a 100% match for the first 6% you contribute. If you contribute 6% that is $1,440 a year you are setting aside for retirement. Your company will match your $1,440 per year, making your total savings $2,880 for the year. This is already a 100% return on your initial investment! If you know of another investment that is guaranteed to get you a 100% return please let me know!
Bad case scenario, let’s say your 401k plan drops 10% for the year. This means the amount you put in your 401k is now worth $1,296. However, your employer would be matching you through the year, giving you an additional $1,296. Add these two together and your $1,440 you saved is now worth about $2,600. An 80% return from what you put down. Still an outstanding investment, even in this bad scenario.
On the flip side, let’s say your portfolio increases 8%, that original $1,440 you put in for the year would turn into $3,110.40.
Sure 6% of your paycheck is a lot of money, but it comes out pre-tax. It does not feel like 6%. For simplicity sake say you make $2,000 a month in gross pay per month. After taxes you take home around $1,400 per month (30% tax rate). Now if you contribute the 6% (or $120/month) to your 401k, you will only get taxed on $1,880 a month. Your take home would be $1,316 (30% tax rate). The difference for your income is $84 a month, not $120 a month. Also this deduction could push you into a lower tax bracket so you could end up getting taxed at a lower rate than before.
So, please set yourself up to make the most of your 401k. Make sure that at minimum you are taking advantage of your employer matching program.