Power Of The 401k Match For A Dividend Income Investor

Includes: VIIIX, VINIX
by: Dividend Diplomats

Ah, the beauty of being a dividend growth investor. There are many, er, most of us that still work for an employer that isn't our own self. Most of us still work for a firm, a company, a business that pay us on a periodic basis throughout the year, whether that be hourly or salary. As a benefit of working for such an organization -- they may offer a matching policy for 401k contributions. Today… yes today, I want to go through the power of the 401k match has on our dividend portfolios!

401k -- Match

The 401k

A 401k is a retirement plan (403b for not for profit organizations) for employers that they offer to employees as a retirement vehicle. The IRS established income limits that one may contribute to the policy in any given year. By the way, as I type this -- this sounds very boring, but trust me -- getting to the numbers, spices it up a bit, so hang with me. It definitely isn't as boring as Bert STILL talking about his ARCP in his last dividend income article. (Bert… still wondering why you didn't make the income list for bloggers in the community? You need some new material, little guy.) Anyway, I digress… employers offer a 401k policy that usually is through an investment provider such as Vanguard, T. Rowe Price, Franklin Investments, etc., and primary vehicles are mutual funds, and a pretty small basket that we can choose from as well; at least mine does.

I won't go into the Roth 401k vs. traditional 401k, as I'm not into doing a tax discussion. But you can't touch 401k contributions (outside of a few exceptions) until you are 59.5 years of age… you can transfer the assets to another account if you leave the company, however, and invest into essentially whatever you want -- even a low yielding, high dividend growth stock, like Lowe's (NYSE:LOW), or back into Franklin Investments (NYSE:BEN) themselves! Obviously, this plan is used to transfer from having pension or defined benefit plans for employees to these plans or defined contribution plans for employees -- to ensure some sort of value in "retirement" and also reducing/taking away the responsibility of an employer to pay for one's retirement. These plans are then used as a way for employees to "save" in a way and now some are mandatory to save a certain % of their income. In this example and discussion, we will use my employer -- and here is their policy: It is through Vanguard and they have 10-15 mutual funds and will match 50% of the first 5% that I contribute. Let's get into more details on the policy, eh?

My 401k Policy -- Example'd

So my 401k from my employer is a 50% match up to my first 5%. Nothing more. That's it and poof… Not the best plan, but not the worst. What this really means is they will contribute 2.5% of my salary to my account, given that I contribute 5% of my salary. Let's say I make $65,000 (for the record, that is not my salary!). I contribute $3,250 during the year and at the end -- they match and add in $1,625 to my account, awesome! My firm does an age-based contribution as well, a "spiff," that gets added to my account based on how old I am. It's roughly 0.62%, so it's not much, and to simplify for math purposes, let's say that's also $375. Total contributions from employer are now at $2,000. Not a bad investment?

The account/fund I have is Vanguard Institutional Index Fund and simply tracks the S&P 500. The current S&P yield is approximately 2.00% (rounded from 1.96%) at the moment, given the slight "mini" downturn we've had. So, my employer just gave me $2,000 and it's invested at 2.00%, adding a very solid $40 to my projected/forward dividend income. That's over a few percent towards my 2015 goal of $6,750 of forward dividend income. This investment pays quarterly and, actually, I will receive the match here in LESS than 3 weeks (approximately the 25th-27th of June). Furthermore, during the last few years I have received it PRIOR to the June ex-dividend data. This means that I already receive dividends off of the shares that the matching contribution buys; it's awesome.

The other key piece to remember is that the fund also has a dividend growth rate to it, in the year 2014 it was around 13%… I mean, luckily, there are 500 companies within the fund and that gives it a chance for dividend increases, dividend cuts and dividend freezes. So this matching contribution is providing future dividend income, that is being reinvested (hence the power of the DRIP) to buy more shares, which these shares have increasing/growing dividends on an annual basis and the cycle continues!

Obviously the cons to the policy are the limited funds you can invest into, it could be a poor match or no match policy -- or hey -- maybe your employer doesn't have a policy at all. I have a great idea; let's look at a 10-year analysis. Starting at age 27, using a $65K (I'm a bit higher here) figure and a 2.5% match, .6181 age based with incremental of .12 with each year (per our firm policy), 7% income growth rate on the investment, 5% salary growth (mine has been a bit higher than this), sadly -- NO DRIP. Let's see the results:

Okay, wow, what does this mean? The 401k contribution match policy from the firm has grown to almost $800 annually over a 10-year period from the matches alone. That's HUGE! That's over $60 extra per month to pay for a few bills or nice meals. What's fun, to note -- this doesn't even include reinvestment. Let's just say -- there is a lot more at the end than $800, considering this investment compounds quarterly… it's insane if we employees don't take part in this!

401k Match Conclusion

To conclude -- we should take advantage of the match as much as our plan allows us to! Even if this causes us to save over 60% of our income to invest up to the match, let's do it! The earlier you can do this, the better off that retirement account will be, so that at one point -- even if you work for an employer, you could consider not contributing due to the compounding that has occurred -- remember the set it and forget it 10-year plan? This can be part of it too. From this very basic plan -- $800 can be had from matching without dividend reinvestment, which I partake in -- so it's even extrapolated even higher/more than what's being reported above. This will help you reach your goals and find that freedom faster!