What does 401K matching mean?
When an employer offers 401k matching, they are guaranteeing that they will match a certain percentage of your contributions. A common match is 50 cents on the dollar. That means if you put one dollar into your 401k plan, they will match your contribution by putting 50 cents in. You just made 50% on your investment!
Why does contributing to your 401K till your company match make sense?
Let’s take a simple example. Suppose your annual family income is 75,000 USD and your company matches 50 cents on a dollar till a max of 4% of your income. In simple terms in a year if you contribute 3000 dollars (i.e. 4%) from your salary, they will contribute an additional 1500 dollars.
Let’s consider the following scenarios,
If you had not contributed to the plan
| Income | 3000 |
| Taxes | - 750 (considering a 25% tax rate) |
| Money in Hand | 2250 |
If you had contributed to the plan and withdrawn the money immediately
| Income | 3000 |
| Company match | 1500 |
| Fee for early withdrawal of money | - 450 (considering a 10% penalty) |
| Taxes | - 1012.5 (considering a 25% tax rate) |
| Money in Hand | 3037.5 |
Effectively by contributing to the 401K till the company match and withdrawing it immediately results in a 35% profit. If you were to invest the money in a growth instrument with this rate of return your money would double every 2 years.
Now let’s take it a step further. What if you were to not withdraw the money from your 401K till your retirement and consider that you retire in 30 years. Consider the average rate of return from your 401K to be 8%.
