How Much Free Money Are You Passing Up?

Contributing to your 401(k) throughout your career might be one of the best financial moves you can make. A key reason is that many plans come with employer matches, where your boss will kick in with a contribution for you based on however much you contribute for yourself. But amazingly, employees leave around $24 billion of that match money on the table in a given year,because they aren't contributing to effectively receive it. That's a lot of free money being passed up -- and some of it may be yours!

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There are generally three types of people who don't qualify for their full 401(k) matches and thus leave that free money on the table:

  • Those who don't contribute at all.
  • Those who don't contribute enough to get the full match.
  • Those who contribute too quickly and get tripped up by their company's match rules.

Even if you're contributing, you might get tripped up

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One of the best features of 401(k)-style plans is also one of the biggest reasons people can get tripped up when it comes to matches: Once you sign up, contributions are generally automatic. So even if you're already contributing to your 401(k) plan, it makes sense to check if you're getting the full match you can.

For instance, many 401(k) plans let you specify the dollar amount you contribute. If you make $48,000 per year, get paid once a month, and have a match of up to 6% of your salary, you'd set your contribution to $240 per paycheck ($2,880 for the year) to get your maximum match.

That seems straightforward enough, but watch what happens if you get a raise to $54,000. Your new contribution level would need to be $270 per paycheck ($3,240 per year) to get your maximum match. If you don't adjust your contribution when you get that raise, you wouldn't be contributing enough to maximize your match. As a result, you'd be passing up the additional free money available to you.

On the flip side, many plans let you specify your contribution as a percentage of your salary but only apply your match on a per-paycheck basis. Say you're an aggressive saver who wants to maximize your allowed contribution -- currently $18,000 per year for people under age 50.If you make $48,000 per year, get paid once a month, and have a 6% match, you'd set your contribution to 37.5% of your paycheck to fill out your plan. Since each contribution is more than 6% of your salary, you'd also get your full match.

Watch what happens, however, if you get that same raise to $54,000 without adjusting your contribution: 37.5% of your new salary works out to $20,250 per year, or $1,687.50 per paycheck. At that rate, you'd contribute the maximum $18,000 after 10.7 months -- or along with your November paycheck. If your 6% match is awarded on a per-paycheck basis, you'd miss out on the match for December because you contributed too quickly, passing up free money that way.

Ironically, in this case, you'd have to slow down your contribution -- to about 33.33% of your salary -- to maximize both your contribution and your company's match.

And of course, if you aren't contributing at all, you're not getting any match, and you're passing up the full amount of your available free money.

What you can do about it

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Contributing in a way that enables you to get your maximum 401(k) match requires you to understand how much of a match you're eligible for and how the match gets calculated and paid. Once you have a handle on those rules, it's simply a matter of reviewing your current contribution rate and adjusting it as needed. That gives you your best chance of maximizing the free money your employer is offering you.

In addition, it's a good idea to review your 401(k) contribution every January and every time you get a pay raise. By reviewing it in January, you give yourself the opportunity to boost your contribution based on any changes in the allowable limits. By reviewing it every time you get a raise, you get a chance to not only maximize your match but also to increase your contribution as your paycheck grows, helping you grow your retirement nest egg that much more quickly.

When all is said and done, your goal with your 401(k) plan is to use it to build a nest egg that will allow you to fund a comfortable retirement. The key tools at your disposal are the free money your employer is offering you in terms of a match, the money you sock away on your own, and the growth of both of those sources of cash from compounding. Leverage all three to the best of your ability throughout the rest of your career, and you give yourself a great chance of reaching that goal.

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Chuck Saletta has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.