One of the easiest rules to follow when it comes to saving for retirement is to not leave free money on the table. Yet that's exactly what too many workers are doing by either investing too little in their company 401(k)s to receive the full company matching contribution or by not participating in the 401(k) at all.
For someone in their early 20s who's just out of college and earning a real paycheck for the first time, the idea of locking up your money in a savings account that shouldn't be touched for another four or five decades may not sound too appealing. In the early years at a fresh college grad's starting salary, a company 401(k) matching contribution might not amount to more than $50-$100 per month. That may not sound like much on the surface but over time those small contributions add up to tens of thousands of dollars or more. Given that most Americans are woefully unprepared for retirement from a financial perspective and just not good savers in general, that free company match is perhaps the easiest way to build up retirement account balances without any additional work.
So let's put some actual numbers on the potential surrounding the 401(k) matching contribution. The assumptions I'm going to use can obviously vary based on specific circumstances but this should represent a reasonable, relatively middle of the road scenario.
Starting salary of $35,000 out of college.
45-year timeframe (using age 22 as the starting point and continuing until the Social Security full retirement benefit age of 67).
3% total company matching contribution.
7% annual rate of return.
3% annual salary increases.
Again, while individual circumstances may result in different inputs, there's nothing in these assumptions that feels unreasonable. The S&P 500 (NYSEARCA:SPY) has historically earned more than 7% per year but using a more conservative assumption is usually wiser. If you take the numbers above and plug them into a financial calculator, you get a result of a little over $311,000 in a tax deferred account. Almost a third of a million dollars in essentially free money just for saving in a company 401(k).
If you take that $311,000 figure and use the old 4% withdrawal rule, you can withdraw around $12,000 in the first year. Now, also consider the example of someone working at a company that matches $0.50 for every dollar up to 6% to receive the full company match. Combine employee contributions (6%) along with company matching contributions (3%) and you have a total portfolio that's nearing a value of $1 million by age 67. Using the 4% rule again, you're now looking at an annual income of $36,000 from one's retirement savings. Add in an income from Social Security on top of that and you have the foundation of a secure, if not lavish, retirement.
As pretty much anyone will tell you, there's no reason why workers shouldn't invest at least enough in their 401(k)s to earn the full company matching contribution. While young workers may not like the idea of saving their money instead of spending it, it's becoming increasingly essential to take advantage of every opportunity available to boost retirement savings.
Taking advantage of the full 401(k) matching contribution and combining it with the benefit of time and the power of compounding may be the easiest and simplest way to achieve that.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.