Milestone 2: Take Advantage of Your Employer Match
By now you should have completed your budget, saved at least $1,000 in cash, and are ready to move on to Milestone #2 on the Next Dollar Roadmap, Take Advantage of Your Employer Match.
- Starting Point: Creating Your First Budget
- Milestone 1: The Uh-Oh Fund
- Milestone 2: Take Advantage of Your Employer Match
- Milestone 3: Pay Off Toxic Debt
- Milestone 4: Fully Funded Emergency Fund
- Milestone 5: Save 15%-25% of Your Income in Tax-Advantaged Retirement Accounts
- Milestone 6: Save for Flexibility in Bridge Accounts
- Milestone 7: Prefund Kids’ Expenses
- Milestone 8: Pay Off Remaining Debt
- Milestone 9: Total Financial Independence
I want to clarify that even though we won’t discuss debt until Milestone 3, focusing on Milestone 2 shouldn’t lead you to ignore your outstanding debts completely.
In all likelihood, you have minimum payments that must be made to service your debts and keep you out of default.
Be sure you are at least meeting those minimum requirements before directing your next dollars to Milestone 2.
With that said, let’s start by covering four reasons employer matching contributions are pegged at Milestone 2 on the Next Dollar Roadmap. Then, we’ll walk through some of the places you can look to maximize the use of your employer matching dollars.
1) Matching dollars are too powerful to pass up
The reason I’ve placed priority on the employer match over paying down outstanding toxic debts (Milestone #3) is the value of an employer match is too good to pass up.
Effectively, the rate of return on the dollars from your employer match is 100% (assuming the employer match is dollar for dollar).
The all-time average rate of return for the S&P 500 is 10.67%. Real estate: just over 10%. Reasonably common or safe investments only go down in return from there.
There just aren’t any other places you can invest and capture a return like that.
Even if by some miracle you found another investment that produced a 100% return, there’s no way it’s going to come without significant risk.
And odds are, your employer provides a match of some sort. In 2024, some 95% of large companies and 86% of small businesses provided some sort of employer match in their 401(k) plans.
2) Even bad debts don’t outweigh the benefit of the match
Even if your employer match isn’t a dollar-for-dollar match, if it’s higher than the interest on your outstanding debts you will likely benefit from taking advantage of it because it’s unlikely you have any debts that have the same or higher interest rate working against you.
Even the worst credit card I know of (that charges a little over 36% interest) would only provide one-third of the benefit as your employer’s dollar-for-dollar match if you decided to pay it off first.
In this case, even a partial match would be better and since contributions to a retirement plan will be invested and growing for years to come, they are likely to produce a greater long-term benefit than paying off a small amount of high-interest debt.
3) Let your boss boost your bucks with the match!
To drive the point home further, a single dollar today is potentially worth over $45 in 40 years (assuming a 10% rate of return).
With a dollar-for-dollar employer match, that same dollar you contributed is potentially worth over $90!
In short, the employer matching programs offered by your company are one of the quickest and easiest ways to supercharge your retirement savings and boost your net worth.
4) Tiiiii-iiiii-i-iiime is on your side, yes it is.
Finally, for those of you who are early in life and your careers, you have something no one else can get: time.
The most important component in wealth building, aside from money itself, is time.
Allow me to illustrate.
Calvin Compounder and his older colleague Larry Latetoparty have decided to get their investing lives in order and begin contributing to their company’s 401(k) plan.
Calvin is 25 and his pal Larry is 45. They have the same job and salary ($50,000), both plan to retire at 65, and both will contribute 6% of their salary to their company 401(k) to take advantage of their employer’s dollar-for-dollar match.
Assuming they generate an average return of 10%, let’s look at the forecast for Calvin and Larry’s plans, respectively.
At the end of 40 years, when Calvin turns 65 he’ll have $271,555.53 from his annual contribution of $3,000.
Larry on the other hand only had 20 years for his balance to grow. As a result, his 401(k) is worth only $40,365.00 when he reaches 65.
This disparity illustrates the power of compounding interest.
You have no time to waste. Start getting your employer matching bucks today!
Where to Get Those Matching Dollars?
There are a couple of common ways your employer might match dollars or provide financial incentives that you should prioritize. Let’s go over some of those now.
Employer-Sponsored Retirement Plans
Some common employer-sponsored retirement plans include 401(k)s, 403(b)s, 457s, and Thrift Savings Plans.
All of these are defined contribution plans meaning that you can elect to have a set or “defined” percentage of your income directed into the account.
The benefit for you is contributions to these plans can be made before they are taxed (this is known as “tax-deferred” or a “traditional” contribution), or after they are taxed where they can grow tax-free thereafter (this is known as a Roth contribution).
For traditional contributions, this leaves more principal to invest and grow, as well as postponing any taxes you’d owe on that income until later in life.
For Roth contributions, any earnings you receive from contributions are allowed to grow tax-free forever.
Contributions made either way produce significant tax benefits.
For example, if your marginal tax rate is 22%, each $100 you put into a 401(k) on a tax-deferred basis will avoid $22 of income taxes until you withdraw it in retirement.
Even the least mathematically gifted among us can understand that the return on $100 invested would be more than the return on an investment of only $78.
On the other hand, if you direct $100 to an account on a Roth basis, you’ll pay $22 in income tax on the front end but the remaining $78 dollars will grow tax-free forever.
If you make a $100 contribution to a fully taxable investment account, you’ll pay the same $22 on the contribution but you’ll also owe capital gains taxes on any appreciation in the value of your investments when you sell them.
Depending on your tax bracket, that could be up to another 20% of taxes that you could avoid by using an employer-sponsored plan.
I will explain the nuts and bolts of various investment account options at Milestone 5. For now, you just need to know enough to get you started in a plan at work.
Roth vs Traditional
As you begin making contributions to your retirement plan at work, you’ll need to make a few key choices. The first is whether to make contributions on a Roth or Traditional basis.
About 86% percent of employer-sponsored retirement plans offer a Roth option. If yours doesn’t then the choice is pretty simple. Traditional contributions are the only path for you.
I’ve already explained that a Roth is taxed before the money is placed into the account while a traditional plan is taxed as the money is withdrawn from the account.
Mathematically, if your tax bracket remains unchanged and your rate of return is equal, the end result for contributing to and investing in either plan is the same.
Go do the math if you want, but it’s true. We’ll walk through an example at Milestone 5.
When choosing between Roth and Traditional contributions, what you really want to consider is your marginal tax rate when you make contributions versus when you make withdrawals.
If you think you will be taxed at a higher rate in retirement because you’ll have so much money saved it’ll be falling out of your super-deep pockets, then the Roth is for you, my friend.
On the other hand, if you are currently in a high tax bracket, you will likely do better to take the traditional route and withdraw or convert your dollars strategically in retirement.
Ultimately, you need to make the best choice you can based on the information you have available and the goals you have financially.
Personally, I prefer Roth as long as my marginal tax rate is less than or equal to 24%.
Given that taxes are historically low right now and the government doesn’t seem interested in spending any less, my opinion is that taxes are likely to increase in the future. So, I prefer to pay now at the tax rates I know today and be done with it.
I may not be right, but there’s no way to know for sure until you begin making withdrawals.
Investment Options
The second decision you’ll need to make is what to invest in after you make deposits into your account.
Ideally, you’ll want an appropriate mix of equities (stocks), fixed-income investments (usually bonds), and cash equivalents (CDs, money markets, etc.) based on your personal goals and ability to tolerate risk.
The fastest easiest path to this is to use target date retirement funds.
Target date funds own a mix of stocks and bonds that are generally appropriate for a person based on how far they are from retirement.
For example, Vanguard’s 2045 Target Date Retirement Fund (VTIVX) has a stocks-to-bonds ratio of 84%/16%.
Since 2045 is still 20 years away, the portfolio of assets in the fund is tilted toward higher-returning, but riskier stocks.
This fund, like other target date funds, will gradually move in a more conservative direction as the year 2045 approaches because it is assumed one’s risk tolerance decreases as he approaches retirement (this is generally true, btw).
If you want to be more involved in your investment choices, then you’ll need to select from the investment options available in your plan.
Obviously, there’s no way for me to evaluate those from a blog post, so we’ll have to settle for a few things to consider when making investment decisions:
- Generally, the further you are from retirement, the higher your tolerance for risk is and the happier you’ll be with a majority of your assets invested in stocks. On the other hand, the closer you are to retirement, the more conservative your investment approach should be. Check out this post about asset allocation for more information about choosing the right ratio for you.
- Once you settle on an asset allocation, if you can try to select investments with low expense ratios. An expense ratio is the percentage that’s held by the manager of the investment to cover the expenses of operating that fund. The lower, the better.
- I would also consider holding at least some portion of the equities in your portfolio in international stocks for the sake of broader diversification.
HSA/HRA/FSA
The vast majority of the time, when the idea of employer contributions is presented, subsequent conversations will focus on retirement plans.
However, retirement plans may not be the only place to grab a savings boost from your boss.
Over the last decade or so the popularity of accounts designed to provide a tax-advantaged method for saving for future medical expenses has grown significantly.
Employers have embraced these accounts because they provide an incentive for employees to accept more responsibility and risk for future medical expenses, thereby reducing the costs of providing insurance benefits.
The good news for employees is more tax-advantaged saving and investing options and the potential for matching contributions that employers may provide.
Let’s start by identifying and defining each of these account types:
Health Savings Accounts (HSAs)
HSAs are the only saving and investing plan that offers an opportunity to avoid taxes on contributions, earnings, and withdrawals (that’s triple tax savings!).
HSAs also provide an opportunity to sidestep Social Security, unemployment (FUTA), and Medicare taxes on contributions if your employer deposits the funds directly through payroll deduction.
HSAs are unique in several ways but mostly because they provide the option to invest the account funds in securities as you might in your 401(k) or IRA. These investments can grow for years or be used for medical expenses at any time.
Another unique feature is that you can also use your HSA as another retirement account.
Any withdrawals made from an HSA at age 65 or older that are not used for medical expenses are taxed as regular income similar to tax-deferred IRA or 401(k) withdrawals.
HSAs are only available if you are covered by a High Deductible Health Plan (HDHP) and can be obtained outside your employer’s plan, but you won’t get any of the payroll tax breaks going in, nor will your employer be able to place matching funds into the account.
For more about HSAs, check out this post titled, “What is an HSA?”
Flexible Spending Account (FSA)
An FSA is an account generally offered by employers that can be pre-loaded annually for expected healthcare needs in the upcoming calendar year.
The contributions are tax-free and can only be used for medical expenses. FSAs do not provide an investment option like the HSA.
Usually, FSA funds that are not used by the end of the year are forfeited to the plan administrator, but some plans allow the funds to roll over.
You are not required to have an HDHP to use an FSA.
For a thorough comparison of HSAs and FSAs, check out this post.
Health Reimbursement Arrangements (HRA)
HRA’s are health spending accounts provided and owned by an employer.
Like an FSA, there is no option to invest HRA funds for long-term growth. However, HRA funds generally are carried over from year to year and made available to employees even after they retire from their company.
HRA’s are a bit of a retainage tool in that most employers will force you to forfeit any remaining balances if you sever employment prior to retirement.
Some plans also do not allow benefits to transfer to surviving spouses or children.
Like an FSA, you are not required to have an HDHP to use an HRA.
So, what do HSAs, FSAs, and HRAs have to do with employer matching dollars?
In many cases, employers will incentivize employees to participate in various health plans and to save for their own future health needs by contributing an employer match or even an annual gift to these types of accounts.
In other cases, employers may use matching or gifted funds to entice employees to exercise more or regularly visit their physician.
For example, at the company I work for, $1,200 is deposited into an HSA each year I sign up to use a High-Deductible Health Plan. Additionally, I can earn up to another $790 by reporting healthy habits like exercising, having an annual physical exam, or maintaining a healthy body mass index (BMI).
Regardless of the employer’s motive, if they offer free money combined with your health coverage you might as well do what you can to accept it.
Wrap-Up
There are lots of free dollars out there and hopefully, you’re in a position to take advantage of it. If so, grabbing those employer-matching funds is a no-brainer and can be a real boon to your financial success.
You might be asking yourself if you should go ahead and contribute above and beyond the amount necessary to receive your maximum employer match.
The answer is, not yet. That’s coming up at Milestone #5. For now, just contribute what your employer will counter with a contribution of their own.
