Should You Invest in a 401k with No Matching?
Laura explains how 401k employer matching works and answers a listener question about what to do when your company doesn’t match your retirement contributions. Find out if it still makes sense to invest in a 401k with no matching funds to boost your account.
Having the opportunity to invest in a 401k retirement plan is a valuable benefit that’s only offered by employers. However, companies aren’t required to match employees’ retirement contributions, so many don’t.
If that’s the case with your plan you may be wondering if it still makes sense to invest in a 401k with no matching.
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That’s exactly what Laneika wants to know. Her email said, “Three years ago I quit my job and used my 401k money to survive. Now I have a great job with a 401k—but my company doesn’t match my contributions. What options do I have?”
In this show I’ll explain how matching works and answer Laneika’s question so you invest the right way and have plenty of security when you’re ready to kick back and enjoy retirement.
Free Resource: Retirement Account Comparison Chart (PDF download)—get the rules for the most popular retirement accounts
What Is Employer Matching on a 401k Retirement Plan?
First, I’ll explain how 401k matching works and helps to boost your account value. It’s free money that comes with certain rules that may vary from company to company.
In some cases, you get matching funds at work even if you don’t invest in a 401k. For instance, your employer might contribute 3% of your salary each year no matter if you contribute to the plan or not.
Most 401ks require you to meet a specific saving goal before matching funds kick in. A popular benefit is to match 50% up to 6% of your pay. For example, if you make $100,000 and contribute 6% or $6,000, your company would match 50%, or $3,000, giving you a total of $9,000 in contributions. Contributing at least 6% of your salary, in this example, maximizes the amount your company is willing to match.
If you contribute less than 6% of your income, you miss potential compensation. For instance, if you make $100,000 and contribute 4%, or $4,000, your match would be 50% or $2,000—leaving $1,000 on the table.
Other terms you might see are to match 100% of what you contribute, up to 3% of your income. Or a really generous match would be 100% of your contributions up to 6% of your pay.
Not meeting the savings goal means you’re missing out on a lot of free money going into your retirement account. That’s a big incentive to contribute at least enough to max out your plan’s match!
But you don’t always own matching funds right away because they can be tied to a vesting schedule. For instance, you might have to be employed for 3 years until you own them. Or you might receive 20% each year over a 5-year period.
However, no matter how long you stay with an employer, you’re always 100% vested in the contributions that you make to a workplace retirement account.
See also: 401k or IRA: Which One Should You Invest in First?
What Are the Benefits of Investing in a 401k Retirement Plan?
While matching is a major advantage that some workers get with their 401k plans, it’s not the only upside to using one.
While matching is a major advantage that some workers get, it’s not the only upside to investing in a 401k. Here are seven 401k benefits besides matching that you shouldn’t overlook:
Benefit #1: Paying less income tax
When you put money in a traditional 401k, you reduce your annual taxable income, which cuts the amount of tax you have to pay. You defer paying income tax on both your contributions and their earnings in the account until you take withdrawals in the future.
For example, if you earn $40,000 a year and contribute 10% or $4,000 to a traditional 401k, you only have to pay tax on $36,000—not $40,000. When you receive your Form W-2 at the end of the year, you’ll see that your wages subject to income taxes are reduced because of your 401k contributions.
However, you’d still pay Social Security and Medicare taxes on your full income of $40,000. Likewise, you also avoid state income tax, but may still have to pay into funds for state unemployment or disability insurance, depending on where you live.
There’s another option gaining in popularity called a Roth 401k. With a Roth, you pay tax on contributions upfront, but then never pay a penny of tax on future withdrawals of contributions or your investment earnings.
This is similar to how taxes work with a Roth IRA. However, unlike a Roth IRA, with a Roth 401k there’s no annual income limit. High earners are never shut out from being eligible to contribute to a Roth 401k.
See also: What’s the Difference Between a Roth 401k and a Roth IRA?
Benefit #2: Making automatic payroll contributions
Another major benefit of investing through a 401k is that regular contributions must come from payroll deductions. While that might seem like an administrative feature, it’s actually a behavioral benefit.
Having regular deductions from your paycheck invested without you having to think about the process or do anything allows your account to grow on autopilot. This is important because by paying your 401k first, right off the top, you don’t have the chance to spend those contributions.
Of course you can log on to your online account and increase or decrease your contribution amount or suspend it altogether if needed. But once you elect a percentage of your gross income or a flat amount to contribute, you’ll be investing automatically every payday.
See also: 5 Retirement Options When You’re Self-Employed
Benefit #3: Getting federal legal protection
A lesser-known benefit of investing in a 401k is that your money gets federal legal protection from creditors through the Employee Retirement Income Security Act of 1974 (ERISA).
A lesser-known benefit of investing in a 401k is that your money gets federal legal protection from creditors through the Employee Retirement Income Security Act of 1974 (ERISA). It sets minimum standards for employers that choose to set up retirement plans and for the administrators who run them.
Let’s say you have money in an ERISA-qualified account, but lose your job and can’t pay your mortgage. If the lender gets a judgment against you, they can attempt to collect debt from you in a variety of ways—but not by getting into your 401k.
Other types of retirement accounts, such as an IRA, are more vulnerable to creditors. Protections for non-ERISA accounts vary depending on the type of account, how much you have in it, and the state where you live.
However, note that there are exceptions when 401k money is at risk, such as when you owe the IRS for federal tax debts, owe criminal penalties, or owe an ex-spouse under a Qualified Domestic Relations Order.
Benefit #4: Having a high annual contribution limit
For 2016, the annual allowable 401k contribution limit is $18,000, or $24,000 if you’re over age 50. This is much higher than the limit for either a traditional or Roth IRA, which is $5,500, or $6,500 if you’re over 50.
While $18,000 might seem like a lofty goal if you’re young or just starting out in your career, make a commitment to contribute no less than 10% to 15% of your gross income for retirement. And by the way, these limits only apply to contributions you make. You can exceed them by getting additional matching contributions from your employer.
Setting up a percentage contribution allows you to add more to your 401k every time your pay goes up. If you get a cost-of-living raise, promotion, or bonus, your 401k deduction will be calculated on your paycheck’s gross amount.
Most workplace retirement plans also have a feature that allows you to automatically increase your contribution percentage every year. Consider setting this up so you boost your savings at least 1% every year until you reach 15%.
That’s an easy way to set yourself up for a secure retirement, and you probably won’t even miss the money as your savings ramps up year after year.
See also: 7 Pros and Cons of Investing in a 401k Retirement Plan at Work
Benefit #5: Having access to free financial advice
After you enroll in any type of retirement plan, you have to choose how to invest your contributions from a menu of options.
Most 401k plan providers are major brokerages, like Fidelity, Vanguard, and Merrill Lynch. They typically offer top-notch resources, such as an online assessment or free consultations with a financial advisor to help you pick the best diversified investments for your situation.
In general, the more time you have until retirement, or the higher your risk tolerance, the more stock funds you should own as a percentage of your overall portfolio. They may be labeled as “growth funds” or “aggressive growth funds” because they give potentially higher returns, but also come with higher risk due to market volatility.
When you have less time or a low risk tolerance you should own fewer stocks and a higher percentage of bond funds or money market funds. You may see these called “income funds” because they offer stable, but lower returns on your investment.
Take advantage of the opportunity to get customized advice and ask questions about the menu of available investment choices.
See also: How to Make Money Investing in Stocks
Benefit #6: Having the option to take out a loan
While it’s never a good idea to raid your retirement funds, taking a loan from a workplace plan can be a better alternative than taking a hardship withdrawal, which comes with a 10% penalty if you’re younger than 59½.
Some workplace plans include the option to borrow from your own account. But you’re generally limited to take out no more than 50% of your vested balance up to a maximum of $50,000. So, if you have $20,000 that’s vested in your 401k, you could only borrow a maximum of $10,000, or 50%.
If you follow all the rules for taking a 401k loan, it’s penalty-free—but not interest-free. You must pay interest at a rate specified in your plan document, which gets added to your account balance. The loan plus interest must generally be repaid within five years.
While it’s never a good idea to raid your retirement funds, taking a loan from a workplace plan can be a better alternative than taking a hardship withdrawal, which comes with a 10% penalty if you’re younger than 59½.
Taking a loan from your retirement plan leaves you with less money for the future, but can also put you in a tight spot if you leave your employer or get fired before the loan is fully repaid.
The major risk of taking a 401k loan is that if you lose your job while repaying it, the entire outstanding balance is due right away, usually within 60 to 90 days. If you can’t pay it back that quickly, the balance is considered an early withdrawal, subject to income tax plus a 10% penalty.
See also: How to Invest Money in Your IRA or 401k Retirement Account
Benefit #7: Taking it when you leave
When I first started working, I was hesitant to invest in a retirement plan sponsored by my employer. I didn’t realize how easy it is to transfer funds out of a 401k and into another one at a new job or into an IRA that you manage on your own.
The portability of a 401k allows you to simply move your retirement savings with no penalty, no matter how often you change jobs.
See also: Where to Rollover Your 401k Retirement Money
Should You Invest in a 401k With No Matching?
These 7 benefits tip the scales in favor of maxing out a 401k before contributing to any other type of retirement account, such as an IRA, or funding a regular, taxable brokerage account. Even when there’s no matching, the benefits of a 401k simply can’t be beat.
So my advice for Laneika is to make maxing out her 401k a top retirement priority. And when you don’t have a 401k at work, the next best option is to max out an IRA. If you’re self-employed you can use a combination of accounts, such as a Solo 401k and an IRA for even more tax savings.
Once you max out every tax-advantaged retirement account that’s available for your situation and you still have more money to invest, then it’s time to fund a regular, taxable brokerage account. Until then don’t take the benefits of workplace retirement accounts for granted.
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About the Author
Laura Adams received an MBA from the University of Florida. She’s an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura’s previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.
