This is the final post in our Retirement Investing 101 series written by Amanda Smith, Client Services Specialist at CESI. Check out Part 1.
During my tenure at Fidelity Investments as a Retirement Representative, I would receive calls from employees who opted out of participating in their company’s 401(k). These calls were my biggest pet peeve, specifically when their company matched contributions made by the employee. What is a company match? A company match is when your employer matches a percentage or dollar amount of your contributions up to a designated percentage or dollar amount. The majority of companies will only make contributions into their employees’ retirement accounts if the employee contributes their own money into the 401(k). There are quite a few misconceptions and misunderstandings on how company matches work, so I’d like to educate those who may not know.
A majority of employers will match a percentage based on how much the employee contributes. For example, an employer will contribute $1 for $1 up to 4% of an employee’s contributions. This means if an employee contributes 7% of their pay into their retirement account, the employer will contribute an equal amount up to 4% into the employee’s retirement account. This is an 11% total contribution into the employee’s retirement account. The recommended amount is 10-15% including any company matching. If an employee only contributes 2% of their pay into their retirement account, the employer will only contribute an equal amount of 2% into the employee’s retirement account. This is a 2% loss of free money the employee could be receiving from their employer. That 2% adds up over a long time but will be missed because the employee chose not to contribute toward their retirement account.
There are many misconceptions and misunderstandings on what vesting means in relation to matching. I’d like to clear these misconceptions and misunderstandings up for you so you have a solid understanding of how vesting works. What does vesting mean? Vesting is an accrual process that determines how much an employee is entitled to keep within their retirement account. The first important note is that all of your contributions are and should be 100% vested, meaning these contributions are solely yours regardless of your employment status with your employer. As far as employer contributions vesting varies among each company. Many employers choose to have a vesting schedule based on an employee’s longevity with the organization. For example, a vesting schedule will be 1 year of employment will be 20% vested, 2 years 40%, 3 years 60%, 4 years 80%, and 5 years 100%. An employee who works for an employer who uses this vesting schedule will not be 100% vested until they have worked for their employer 5 years. So how does this effect you? I’ll explain. If an employee terminates their employment after 2 years, the employee is only entitled to 40% of the company’s matching contributions and the remaining amount goes back into the company’s funds. The employee is not entitled to the remaining amount because they did not work for the company a full five years according to the employer’s vesting schedule.
I cannot stress enough how important it is to contribute into your employer’s 401(k) program for the matching portions at the very least. Further, make sure you know exactly how your employer’s 401(k) program works, particularly the vesting schedule as this may determine your choices of whether to leave your employer or not. The information is readily available to you from your company’s Human Resource Manager, HR website, or pamphlets provided to you upon hire. Again, do not miss out on free money given by your employer!
Thanks for joining us for our Retirement Investing 101 blog series! Start over at Part 1.