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120% Rate of Return

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If your employer offers a pre-tax retirement savings plan like a 401k, 403b, 457, or similar and they offer a matching contribution you may be the lucky benefactor of a 120% rate of return on your contributions.

Let me explain. Lets assume the following:

$50,000 annual salary
Your employer matches 100% of the first 3% of your contribution. So if you contribute 3% of your salary to your 401k, your employer will also contribute 3% of your salary to your 401k.

Here we go:

Your contribution: 3% of $50,000 = $1,500
Your employer matches $1,500 (100% of your $1,500 contribution)
You also saved $300 of in taxes because your contribution was made pre-tax.
(If you didn’t contribute to your 401k: 20% Federal Tax on $50,000 = $10,000 but
since you contributed $1,500 to your 401k: 20% Federal Tax on $48,500 = $9,700.)

Therefore, of the $1,500 you contributed to your 401k, you earned $1,500 from your employer match plus another $300 in tax savings from the IRS. So your $1,500 contribution turned into $3,300 almost instantly….alas, your 120% rate of return. To put that into perspective, the stock market has averaged about 9% annually over the past 90 years. That means, at those historical returns, it would take almost 10 years to get the same return that your employer (and the IRS) could be offering you right now!

The moral of the story here – no matter what, do not let yourself miss-out on this 120% return. Even if you are working to pay off debts, this is free money no matter how you look at it and we recommend that you take advantage of it. Ideally, you should be contributing more to your 401k but at a very bare minimum, stop right now, call your human resources person and make sure you are signed up to be contributing at least enough to get the full match from your employer. Your future retirement lifestyle thanks you!

Published on October 10, 2014