Millionaire Rule #7

Fund 401(k) to Get the Full Match
There is no better way to save for your financial future than to take advantage of a 401(k) which is matched by an employer. It is rare that I will state anything in the personal finance domain with this much certainty. An employer match is free money. No offense intended, but you would have to be an idiot to ignore FREE MONEY!

For those of you who have never heard of a 401(k) or don't really understand them I will give a quick primer. It is named after the section of the tax code which defines the rules of these accounts. A 401(k) is a savings account for the purpose of funding retirement. If you take money out before age 59 1/2 you will owe taxes and a 10% penalty to the IRS (DO NOT DO THIS). Money contributed is completely protected from taxes until you withdraw it. This tax benefit means that you can avoid taxes now. By avoiding taxes you will have more money to save, and each year your savings will continue to grow tax free until retirement.

A 401(k) account is set up by your employer, held at an independent financial services firm, and managed by YOU the investor. You choose how much goes into the account each pay check (call your HR department to set this up) and you pick your investments from a list of choices provided by the servicing firm. Lastly, and most importantly, many employers encourage employees to save by contributing money on the employee's behalf. This is called "matching" because it is normally arranged such that the employer will kick in a certain percentage of what the employee contributes. Common matching arrangements are 50% of every dollar up to a maximum of 3%; in this case an employee would contribute 6% of their gross pay and the employer would add an additional 3% (for a total of 9% of gross pay saved). Some employers are very generous and offer even more free money!

I will give a simple example to show the power of a 401(k). Lets consider Joe, a regular guy making $50,000 a year. Each year he will get a small raise of 3% and his investments return a moderate 8% per year. He is 30 years old and will work until he is 67 year old. The table below shows Joe's results depending on the type of investment account he uses.



I will say again, that not putting in the money necessary to get the full match is leaving free money on the table; don't do it. The best case shown in the table produced a nest egg of over $1.28 million which is roughly double what could have been saved in a taxable retirement account.

Now I realize that not every person has been lucky enough to find a job that offers a 401(k) and that a match is not offered in all 401(k) plans either. Do not loose hope! There are still other retirement saving options that are pretty good. If you want more information on your choices, continue reading the rest of my series Millionaire Rules.