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Infographic: Are You Walking Away From Your Employer’s Free Money?
401k Employer Match Explained (And the Traps to Avoid)
Imagine your employer gives you $256,000 in free money, and you lose every single penny without doing anything wrong.
All because you missed this one thing buried in the fine print that gives your employer the right to take it all back – legally.
2/3 of employees never learn this, but give me 5 minutes, and I’ll show you exactly how to claim every dollar your employer owes you, and the one number that decides when it’s really yours.
What is a 401k Account
To get this free money, you need to contribute to an account run by your employer. But how much depends on the formula your employer uses, and misunderstanding it is an easy way to leave thousands of dollars on the table.
This account is a 401k, which is a type of retirement account. You avoid paying income tax on the money you contribute today – you only pay tax when you withdraw the money in retirement.
Your employer sets it up, and usually matches your contributions up to a certain percentage of your salary.
401k Employer Match
One of the most common kinds of matches is 50 cents on the dollar up to 6% of your salary.
If you earn $60,000, 6% of your salary is $3,600. So if you contribute $3,600 or more, you will get $1,800 from your employer – which is the maximum possible match.
But if you contribute less, say $2,000, then you’d miss out on $800 of free money.
This employer match might not seem like a lot now, but it will grow significantly by retirement thanks to compounding.
Imagine you start getting the $1,800 in free money at 25, and invest it in the stock market every year. When you retire at 65, the employer contributions alone will be worth over a million dollars!
This is why it’s important to know your employer’s match rate, and more importantly how much you need to put in to maximize the free money.
This is usually a percentage of your salary, and you can find it by opening your employer’s benefits portal and looking at the 401k details.
Don’t worry about the details of investing yet, just make sure you’re contributing enough to take full advantage of the match.
But if you don’t know this next part, you could lose the million dollars – even after getting the full employer match.
401k Vesting Schedule
Most people think the money your employer contributes is yours, which makes sense.
But employers have a way to take that money back, even after they deposit it in your account, and they hide it in the fine print. In fact, research from Vanguard and Fidelity shows ⅔ of employees don’t even know about this.
While studying for the CFP® exam, I learned that the matching contributions aren’t actually yours until you’ve been with the company for a certain number of years. This is called a vesting schedule.
It means that if you leave for another job too soon, your employer can take back all or part of the money they contributed. Let’s look at some examples.
A common vesting schedule is 6-year graded. The full schedule is above, but the important part is that while you get some ownership of the employer match over the years, it’s only a 100% yours after you’ve been with the company for 6 years.
So if you leave any earlier, you’ll lose at least some of this free money.
Another vesting schedule is a 3-year cliff, where you get no ownership of the employer match until you complete 3 years. So if you leave even after 2 years and 11 months, you lose all of it.
Imagine you get $1,800 of free money every year, but leave just before 3 years have passed. You’d lose $5,400 of free money – which would be worth $256,651 by the time you retire at 65!
Keep in mind that the money you contribute from your paycheck is always yours – it’s just the employer match that you might lose if you leave early.
But often, 401ks have immediate vesting, which means even if you leave your job just after joining, you’ll keep all the free money.
To find out which vesting schedule your 401k uses, look at the Summary Plan Description. Most employees don’t, but reading it could help you avoid a costly mistake.
But just putting money into the 401k doesn’t do anything – you have to actually invest it. If investing seems complicated, don’t worry.
I’ve made a complete step by step beginner’s guide with everything you need to get started, so you can make the most of the free money and work toward becoming a millionaire: The Right Way to Invest Your First $1,000 (That Builds Real Wealth)