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The Math Behind Why You Should Contribute to a Matched Retirement Plan

Steven Orlowski

NEW YORK (MainStreet)—Don't Turn Your Back Free Money

Everybody likes to get free stuff, right? But who in their right mind would turn down money for nothing?

O.K., technically it's not for nothing (you need to be employed to get it), but for many U.S. workers "free money" is available through their employer sponsored retirement plans.

Unfortunately many employees, and frequently younger ones, do not take advantage of their retirement plans and therefore say no to what amounts to an increase in pay.

How to Master a 401(k) and Roth IRA at the Same Time

You see, younger workers sometimes think that retirement planning can wait until they are older. But it's a mathematical truism that the best time to start saving is when you're young...

...and the younger the better.

Now, if you're planning on being the next Mark Zuckerberg then maybe you don't need to read the rest of this article...but most of us will not be like Zuck.

However, you can get rich. And one way to make sure you do is to start saving early, save a lot and take advantage of your employer's retirement plan matching contributions.

Sign-up Yesterday

Most of us will not retire with an old-school defined benefit pension. You know the kind. You retire after working for the same company for 25 years and a deposit magically hits your checking account every week for as long as you live.

You parents may have one, and your grandparents probably have one; but you most likely won't. You should however have access to a defined contribution retirement plan like a 401(k) or a 403(b).

These accounts allow you to save a percentage of your income up to a maximum limit which is set by the government. That's a maximum of $17,500.00 for 2013.

Now, some people would rather spend money today than save for a retirement that seems so far, far away...

But if you do, you could be forgoing a very big benefit that your employer may be providing you with...those matching contributions.

You see, as traditional pension plans were phased out companies instead shifted to plans like 401(k)'s where the burden is on you to save.

If you choose to participate in the plan, terrific; your employer might match a percentage of your savings.

If you do not participate you're turning a blind eye on extra compensation. And it's your problem, not your employer's...

How does it work?

How To Consolidate Your 401(k)s

Let's say we have a friend named Fred. Fred is 25 years old and he makes $50,000 a year. Right now Fred has a $0.00 balance in his 401(k).

Let's see how much Fred might have saved for retirement if he started now under a couple of different scenarios. To get these numbers I'm using the Fidelity Investments Contribution Calculator.

Fred has been thinking about putting $1,500.00 per year into an IRA. But an IRA has no matching contribution. But if Fred does contribute $1,500.00 to his IRA every year until he's 60, for 35 years, and his investments grow at 8% per year, Fred would end up with $289,369.00 saved for retirement.

That's O.K. But he could do better by using his employer sponsored 401(k).

You see, his employer will match dollar for dollar up to 3% of Fred's contribution to his 401(k). If Fred were to contribute $1,500 to his 401(k) instead of his IRA Fred's employer would match his contribution (3% of $50,000 = $1,500) and also put $1,500 into Fred's 401(k).

When Fred reached age 60 he'd have twice as much as in the IRA - $578,728 - thanks to those matching contributions!

And if he got aggressive with his contributions, let's say contributing 6% of his salary ($3,000.00) each year, Fred would end up with much more - $1,061,019.00.

But Fred needs to start right away. If he waits, let's say until he's 35, he'll have to contribute far more to retire with a similar 401(k) balance.

In fact, a 35-year-old Fred making the same amount of money would have to contribute 23% of his income each year (instead of 6%) in order to match the amount he'd have had if he'd started at age 25 - $1,037,972.00 to be exact.

Of course many of us do not expect to have the same job with the same income for our entire careers like Fred. Most of us strive for bigger and better things - better jobs with higher incomes which would enable us to save more...

But we never know what the future has in store for us.

So start saving now and take advantage of your employers matching contributions.

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