Why Your 401(k) Employer Match May Not Be Free Money
Anytime you come across a personal finance-related article, chances are, you'll likely read advice from a financial advisor or "personal finance expert" preaching you should contribute money to your 401(k) up to the employer match because it's essentially "free money." Sound familiar?
Unfortunately, this type of blanket advice is not always true and could be dangerous, especially if one is trying to pay down high interest credit card debt.
Here's why your 401(k) employer match may not be free money after all.
Employer Contribution Timing
The most generous 401(k) plans match your contributions each pay period while the least generous plans only provide the employer match once a year, typically at the end of the year.
This means, if you contributed money to your 401(k) in the beginning of the year, but switched companies in the summer, unfortunately, you wouldn't be eligible or have received the employer match at all in the situation where the company matches once a year.
Justin Chidester, financial planner at Wealth Mode Planning, said, "The average person supposedly changes jobs 12 times during their career, which means that could be at least a dozen matching contributions that you could lose out on. That can add up to tens of thousands of dollars over a lifetime."
Aside from the obvious downside of not getting the employer contribution, two additional downsides are losing out on growing your money for a longer period of time and not being able to take advantage of dollar cost averaging. When employer match contributions are given to the employee at the end of the year rather than per pay period, the employee loses out on up to 11 months of potential market gains on the matching monies.
Similarly, lump sum contributions expose employees to market prices at one moment in time, which could be good or bad, rather than various prices throughout the year that average out.
Vesting Schedules For Employer Contributions
Just because an employer has deposited match monies into your account, doesn't mean you'll actually be able to keep them. While the most generous plans allow employees to be vested in employer contributions immediately, the least generous plans have vesting schedules that may require you to be at the company for as long as six years before being fully vested in employer contributions.
"Employers frequently put vesting schedules in place as part of employee retention programs," said Dan McElwee, a Partner at Ventura Wealth Management. "We advise that employees do not think of all of an employer's contribution as "theirs" until the funds have fully vested. Employees should know when they become fully vested. It is clearly stated in plan documents."
As a benchmark, of the plans Vanguard administers, 53% have vesting schedules associated with their employer matches.
The two main types of vesting schedules are 1) cliff vesting or 2) graduated vesting. Cliff vesting requires employees to work at a company for a minimum number of years before their employer match monies are vested fully. An example would be a company requiring employees to remain at the company for three years before their employer match contributions are 100% vested.
Graduated vesting, on the other hand, allows a portion of employer contributions to be vested over a period of time. A sample vesting schedule may be 20% vested per year until you are fully vested after five years.
While vesting schedules may not be beneficial for frequent job hoppers, from the employer's point of view, these vesting schedules are meant to help them retain talent. As a business, it can be very expensive to frequently recruit and train new employees, so these vesting schedules may allow employers to keep workers longer.
According to the Bureau of Labor Statistics, the median number of years that an employee has been at their current employer sat at approximately four years as of January 2024, but this figure is skewed higher because of those 45 and older who have been in their position about 7-10 years. Those aged 25-34 have been in their jobs, on average, less than three years.
Should You Contribute?
Determining whether you should save for retirement should not be influenced by whether your employer provides a 401(k) matching contribution. However, if you are balancing other pressing goals, such as paying down high interest debt, it's important to read your 401(k) plan documents carefully to fully understand contribution timing and vesting schedules for employer matching contributions. Knowing these details could materially impact whether it makes sense for you to utilize monies to fund your 401(k) or toward other financial goals.
While you should monitor your finances throughout the year, the month of October presents a unique opportunity. "October is a great time for a 401(k) check-up because it provides an opportunity to begin to discuss open enrollment and your options for next year as well as evaluating what you should do for the remainder of the current year, says Eric Hon, Certified Financial Planner at Newport Advisory.
Beyond understanding your current 401(k) plan, it's important to take a company's 401(k) plan and other benefits into account when evaluating job offers. Because of the variation in plans, differences in 401(k) plan features could materially impact your total compensation package.