How Some Investors Miss Out on $1,336 of Free Money in Their 401(k)s

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The 401(k) is one of the greatest gifts to retirement savers, but millions of people are collectively leaving behind billions of dollars in nearly free money. As many as 25% of savers aren't fully maximizing the benefit of their employer match on their 401(k)s, leaving as much as $1,336 on the table each year, according to a report by retirement account manager Financial Engines.

401(k) matches add up to real money

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Most 401(k) plans have some kind of matching program wherein employers match employee contributions to a 401(k) with extra cash on top. A prototypical match is 50% of all contributions on up to 6% of the employee's pay.

Thus, under this system, an employee who sets aside 6% of his or her salary would receive another 3% of this salary in his or her employer 401(k), boosting the savings rate to 9%.

In terms of dollars and cents, this means that someone who earns $50,000 would contribute $3,000 (6% of pay), and thus score a free $1,500 (3% of pay) from his or her employer through the matching program.

Why you should always max out your employer's 401(k) match

Maxing out your employer's match is the financial equivalent of giving yourself a raise. The average potential match in the United States was 3.57% of employee pay, according to a 2010 report by the Bureau of Labor Statistics. That's roughly equal to an extra paycheck once a year.

People who max out their employer's match get the equivalent of an immediate risk-free return on their investment. Assuming your employer matches your contributions at a rate of 50%, you could be missing out on a 50% return on your money by contributing too little to your 401(k).

Consider this scenario: Sally started working in 2007, earning a salary of $50,000 per year, which has since increased at a rate of roughly 2% per year. Since day 1, she's set aside 6% of her pay in her 401(k), which her employer matched at a 50% rate. She invested her money in an S&P 500 index fund, letting the stock market work its magic for her.

Today, her 401(k) balance stands at nearly $99,800, more than three times what she has contributed from her salary, thanks to rising stock prices and her employer match, which is responsible for a third of the gains over time.

A boon in bull and bear markets

Sally really benefited from a bull market in stocks, but her employer match significantly reduced her risks during the 2008 downturn, which occurred shortly after she started investing.

Her account balance only briefly declined to less than her cumulative contributions, all thanks to the buffer provided by her employer match. In effect, the employer match nearly eliminated the downside of investing in the stock market by papering over the losses she (temporarily) endured in the financial crisis.

If you do just one thing to improve your finances in 2018, look at your 401(k) to double check that you're investing at least enough to get the full benefit of your employer's match. You could be missing out on thousands of dollars in free money every single year.

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Jordan Wathen has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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