In personal finance, there are some undeniable pieces of conventional wisdom:
- Save 30%+ of your income
- Have a 3-6 month emergency fund
- Fund your retirement through investments, Social Security, and a 401(K)
But when you look up close, 401(K)’s aren’t all they’re cracked up to be. I’m at that point in the #StartupGrind where I’m actually offered a 401(K), and while I’m thankful for the 3% company match, I’m not thrilled about some of the strings that come with it – and it doesn’t seem like people are talking about them!
With the fees, rules around employer matches, and tricky advertising, you might not be getting what you sign up for.
In the interest of clearing up the sticking points, here are a few details about your 401(K) that your employer might not be broadcasting – and better yet, what to do about them:
Your 401(K) contributions are taken from your paycheck, but more often than not, they don’t hit your account at the same time. Most companies delay funding 401(K) accounts by anywhere from 3-5 business days after sending out paychecks. Not the end of the world.
Some employers, however, legally deposit those contributions up to 15 business days after your paycheck was sent out. That’s 3 weeks to see your cash! Sure, it’ll eventually come in, but for those of us in the startup world, it helps to set a calendar reminder, just in case your payroll team misses the contribution entirely – which, yes, has happened.
We’re all excited to hear about the fabulous employer match – free money is free money, after all! But it’s easy to be dazzled and confused. Whether you’re getting a 100% employer match of up to 3% of your salary, or a 50% employer match of up to 6% of your salary, it’s the same exact thing.
It’s basic math. Employers will market their matches as X% of Y% of your salary, meaning if you invest up to Y%, your employer will match X% of that total contribution, or X% times Y%.
For example, if you’re earning $48,000/year and your company matches 100% of up to 3% of your salary, and you invest the full 3% ($1,440/year), your company will also invest $1,440 for you. Yay! That’s an extra $1,440 I don’t have to work for!
Meanwhile, if your same company only matches 50% of your qualifying contributions, you’d still put in $1,440 but only see a match of $720/year. Womp womp.
Free money is free money, but double check on those percentages, and know exactly what your employer will match.
Paycheck to Paycheck, or, “Not All At Once”
Not a bad thing, but worth noting for the newly inaugurated 401(K) owners: you can’t invest 6% of your salary in a lump sum and expect to get the full match. Your company is smart! They want you to stick around, and giving that much free money up-front won’t make sense to them.
Instead, you can expect a match per pay period.
Let’s say you make $48,000/year for simple math. You earn $2,000 twice a month. If you invest 3% ($60) of each paycheck into your 401(K), you can expect to see that matched.
However, if you were to try and put all $1,440 of your potentially matched cash in ASAP, you’d still only see a $60 match. Pace your investments out so you can get the full benefit!
Lump Sum Matches
Employer matches are pretty much the best reason to sign up for your company’s 401(K), but be aware: your employer might not match your contribution up front.
As much as I love my current company (and my god, I really do), they contribute year-end matches, rather than doing it pay period by pay period. This might not seem like a big deal, but delaying the investment to the end of the year means, on average, you’re missing out on $40,000 by the time you retire, thanks to the compound growth you miss out on every single year. Ouch.
If you, like me, are working with a company that waits, talk to your HR team. While there may be a business reason for the delay, it’s just as likely that this detail was overlooked when they set up the 401(K) program in the first place. Or it’s possible that there was a business reason when they set it up, but it’s no longer an issue now. Either way, it doesn’t hurt to ask!
Employer matches are always touted as the only guaranteed 100% return you’ll ever get, but they’re actually not guaranteed. Instead, they come with a vesting schedule – usually one of two schedules dictating when you actually get to keep a percentage of that match.
If it’s 2-6 year graded, you get 20% of the match after 2 years, and an additional 20% each year thereafter.
If it’s a 3 year cliff, you won’t get to keep a penny of that match until you’ve worked there for 3 years. But once you hit that milestone, you get it all.
Most employers use these company matches just like stock options. They’re a way to retain their talented team members – and avoid losing money when an employee moves on to their next gig too soon. Think of a vesting schedule as your boss saying “yes, you can have this extra money, but you have to stick around to actually own it!”
This makes perfect sense – why would your boss just throw free money at you? Still, I wish more people knew that if you leave the company before your 2nd or 3rd year, you can kiss that sweet, sweet employer match goodbye.
No way to sugarcoat it: a 401(K) will never offer you access to all of the stocks, bonds, and funds that you really want to invest in. They have a handful of funds that you can choose, and usually they’re a small combination of:
- Stock-Based Funds
- Bond-Based Funds
- Target Date Funds – managed funds which go from stock-heavy to bond-heavy as you get closer to retiring on that “target date”
*note that this problem can be helped if your employer offers a Self Directed option, meaning you have the freedom to select your investments. Talk to your HR!
You’re able to mix and match from maybe 15-30 choices, but each of those funds has a fairly hefty Expense Ratio (read: annual fee), ranging from 0.5% to a whopping 1.25% of your investment. Every. Year.
This might not sound like much, but I did the math. At least for my company, the difference between investing independently versus in the 401(K) is anywhere from a 0.20% to 0.81% markup. If I were maxing out my 401(K) each year at $18,500 in investments, that’s up to $150/year on that investment, every year, that I would get to keep if I’d just invested in the same funds elsewhere.
Down the line, it really adds up!
So do your homework before you start settling on funds all willy-nilly. I set up a spreadsheet, and fill in each fund’s information. This includes the dividend (or, the share of profits that you’ll receive each year, just for holding the stock), the average annual return on investment, the expense ratio through my 401(K), and the expense ratio for a matching fund if I didn’t go through my 401(K).
This spreadsheet will then spit out what I can expect to earn just by holding that fund, assuming the data’s right, and can steer me away from the funds that will literally lose money for me, just by holding them, every year.
I’ve made a template spreadsheet, which you can grab here, just in case anyone else is in the same boat and wants to make sure that they’re not being duped. The highlighted cells can be changed to match your 401(K) funds, and you can directly compare what they advertise as a potential profit, vs. what you would earn in the real world without their fees. Assuming their averages and info is correct, this should help!
And then there are “management fees,” or what the 401(K) brokerage takes regardless of what funds you select. These are tagged as Recordkeeping Fees, Investment Costs, Advisory Service Fees, Individual Service Fees… and while some employers cover them, many don’t.
The good news is companies like Captain 401 are starting to make moves to bring the average fees down. The bad news is that this takes time, and proactive involvement from your HR team. If they don’t have eyes on your 401(K) fees, you’re not going to see them drop.
While there are issues that nobody seems to be talking about, there are ways to skirt them. Be aware and talk to your HR team about your 401(K) plan, so you know how to get the best results. You can’t control everything, but you can make smart decisions that will get you the most out of your company’s 401(K). At the very least, get that match.
Is a 401(K) the magical solution which will bring a pot of gold at the end of our career rainbow? Eh… But it is tax-sheltered, so it’ll have to do.
My favorite free financial tool I use is M1 Finance. I've previously written about M1's free trades, automatic rebalancing, and easy-to-use interface, but it really does make investing accessible and easy. If you're not already investing in some way, or if you're looking for a tool that makes it easy to manage, I recommend trying it out.
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