O’Connor: Want to live long and prosper? Take the free money!
Correction: This article has been updated to clarify options for contributions once annual IRA contributions have been maxed out.
Any “Star Trek” fans out there? If so, you’ve probably heard of The Prime Directive which, in Trekker lingo, is the strict prohibition against interfering with the internal development of ignorant, backwards alien civilizations, such as people from the planet Bajor or, closer to home, season-ticket holders of the New York Jets.
When it comes to my own immense personal finance success as a mostly paid newspaper reporter, my own prime directive is, “Always take free money. Because, hey, free money!”
OK, so not as sophisticated as “Star Trek” but, in my defense let me just say, “Hey, free money!”
Unfortunately, many of you out there are violating my prime directive. In the world of personal finance, this makes you the equivalent of that red-shirt security guard on the Enterprise landing detail who beams down to the mysterious alien planet and gets vaporized before the opening credits.
‘Your nest egg is dead, Jim’
I say this because some of you are putting your retirement at risk because you still haven’t signed up for your company’s 401(k) retirement plan. Which, in many cases, means you are leaving a chunk of free money (!) unclaimed during each and every pay period.
This is somewhat understandable, because enrolling in your 401(k) usually comes up in October, a month known for beer festivals, baseball playoffs and pumpkin spice.
October is also the month when anybody who has a job gets hit with pile of paperwork to sort through to choose next year’s health insurance. After wading through alphabet soup of health plans, from HDHPs with HSAs, HMOs, PPOs and FSAs, your eyes likely glaze over and your brain hits overload by the time you get to anything about your 401(k).
The problem is that signing up for employer health care coverage comes down to solving the riddle of how your boss is going to give you less this year while charging you more and claiming that it’s all to serve you better. Although “you” in this case translates as, “our stockholders who viscerally detest the fact that we can’t outsource all your cotton-picking jobs to a call center in an unheated yurt on the steppes of Outer Slobovia.”
But signing up for your 401(k) quite often means free money (!) because your employer will match whatever amount you save, up to a limit. The most common situation, according to a 2014 survey by the investment management company Vanguard Group, is where the company gives workers 50 cents for each dollar they save, up to the first 6 percent of their pay. In dollar terms, it means if you make $40,000 a year and save 6 percent of your pay, or $2,400, into your 401(k), your boss gives you $1,200 in free money (!).
Which, as we have established, you always want to take.
No employer match? Highly illogical
Look, 401(k) accounts on their own aren’t the greatest investments. They can have a lot of fees, a bunch of lackluster, underperforming investment choices and lots of restrictions. So why bother? First, because any money you save in them is tax-deferred, which means it all compounds over time at a higher value, and then you pay taxes only when you withdraw the money in your dotage. But the best reason is — you guessed it — free money (!).
You can choose the worst possible combination of mutual funds offered in your 401(k) and it doesn’t matter a whit, as long as you save up to the maximum level of your employer match, because that means you’re automatically getting a 50 percent gain on your money. Every pay period, with no deviation. There is no other investment that can guarantee that kind of return anywhere in this solar system.
So, if your employer offers a match, wade through the extra pile of paperwork to get that free money (!). If you can’t hit the maximum level for the employer match, start with at least 2 percent of your salary (you won’t miss it) and increase that by 2 percent each year until you hit the max. The best part: Because it’s all pre-tax, your take-home pay actually will be reduced by less than the full amount you contribute, which is really, really neat.
You should, however, do a little homework. Research the investment choices in your employer’s plan, and choose a mix of investments with the lowest cost. You can find a good suggested model portfolio at 401khelpcenter.com (search for “Asset Allocation Made Simple”) and you can find a good guide to funds and fees at Morningstar.com.
But wait — there is one class of planet in the 401(k) universe that won’t support investment life, and it’s located in the heart of the Scrooge-Loser-Cheapskate-Skinflint-Jerkwad nebula: a boss who doesn’t offer an employer match. In that case, skip the 401(k) and put your money into a Roth Individual Retirement Account. Then, if you max that out, you can look for other tax-deferred options, such as certain types of life insurance.
And one more thing — start hunting for a job with a company that treats you right, in the form of a 401(k) match. When you get an offer, clean out your desk, give your notice and declare, “Beam me up, Scotty — this planet stinks!”