Personal finance is a balance between enjoying the present and preparing for the future. It’s very tempting to save less, or not save at all, so that you can have more money available to take home and use for things you want to do in your life now. I battle that temptation too.
But, taking home that extra pay instead of saving it probably has a higher opportunity cost than you realize. Here’s why you should look at the math and you should always try to get the full 401k employer match!
The Premise
Getting your savings rate to your goal, or increasing it even further, can feel daunting. If you are just getting by on your take home pay now, there’s no way you could afford to save more… right?
Well, if you’re saving through paycheck withholding into a pre-tax/tax deductible account (like a traditional IRA, 403b, 457, and most 401k plans), the extra savings might not hit your budget as hard as you would expect. Let’s run the numbers. We’ll compare take home pay vs 401k contributions vs getting the full 401k employer match.
Consider if you plan to save an extra $100 from your paycheck into your 401k. Let’s say you live in Kentucky, file jointly with your spouse, have a 1% municipal income tax, and you each make $45,000 annually. I chose Kentucky for this example since they have a moderate state income tax rate.
We won’t worry about insurance costs or FICA (Social Security and Medicare) tax deducted from this $100 portion of the paycheck, since you’re already paying those (FICA is calculated based on your gross pay). You don’t avoid either of these expenses when you defer income into a “pre-tax” account, so those are sunk costs and not relevant for this comparison.
Here’s how that $100 would look if it was part of your take-home pay, not going into your 401k.
Comparisons
Tax Breakdown for $100 Incremental Take-Home Pay
| Gross portion of pay | $100 |
| Federal income tax (12% marginal tax rate, assuming standard deduction) | $12 |
| State income tax (6%) | $6 |
| Municipal income tax (1%) | $1 |
| Take home pay | $81 |
So, if you choose to save the extra $100 into your 401(k), it won’t “cost” you $100 in terms of take-home pay. Only $81.
401(k) contributions are exempt from federal income tax, and usually exempt from state and local taxes as well.
If you’re not yet receiving your full employer match for your 401(k) contributions, then that makes the effect we’ll see below more dramatic.
A 50% employer match to your 401(k) contribution (up to a certain limit) is fairly common, which would mean $150 into your account. Some employers even match 100% of your contribution, with limits — so you’d be investing $200!
Now you’re comparing $81 take-home pay with $100 or up to $200 into your 401(k).
If you’re 30 now and you plan to keep your 401(k) funds invested until you’re 60, that will allow 30 years of growth. Let’s look at the long-term effect of one paycheck with these specifications.
Your $100 Invested One Time Pre-tax for 30 Years, at 6% Growth Rate (Compounded Monthly)
| Investment Amount | $100 | $150 ($100 with 50% match) | $200 ($100 with 100% match) |
| Additional Monthly Investment | $0 | $0 | $0 |
| Growth Rate | 6% | 6% | 6% |
| Years Invested | 30 | 30 | 30 |
| Value After Growth | $602.26 | $903.39 | $1,204.52 |
Even if you were already receiving the full match (so you wouldn’t get a match on this extra contribution), the $100 growing at 6% would be worth $602.26 in 30 years.
But, what if you contributed that extra $100 every month, not just once?
Your $100 Invested Monthly, Pre-tax for 30 Years at 6% Growth Rate (Compounded Monthly)
| Monthly Investment | $100/month | $150/month ($100 with 50% match) | $200/month ($100 with 100% match) |
| Growth Rate | 6% | 6% | 6% |
| Years Invested | 30 | 30 | 30 |
| Value After Growth | $100,451.50 | $150,677.26 | $200,903.01 |
I used the 6% rate to try to account for future inflation, so these values represent the present dollar value. If you use 9.5% growth rate instead, the numbers explode further. $100 monthly for 30 years comes to $203,303 and $200 monthly comes to $406,607.03
Key Takeaways
1. Sheesh! Make sure you’re always at least getting your full match if your company offers it. It’s literally free money, and it will supercharge your retirement investments.
Typically you’ll want to be saving even more, but even in the tightest financial times it will be worth it to get the match, at a minimum.
2. A small increase in retirement savings rate can make a significant difference since we’re likely dealing with a long time horizon.
Even if you’re already 50, you won’t be immediately using all of your money when you retire. It’s very possible, even likely that you’ll still have a large portion of your portfolio invested when you’re 80. Compound interest isn’t just for people early in their careers!
3. Tax-deductible savings “cost” you less than it seems. In this case, $81 per month earned (take-home pay) could be $200,903 saved in your 401(k). In a way, it costs you much more to not save it.
Do you prioritize getting the full match from your employer, if they offer it? What would you consider to be more important financially than getting the match?
Related posts from Semi-Retire Plan:
- 10 Ways to Consider Saving for Your Kid’s College
- How to “Bridge the Gap” and Access Your Retirement Accounts Early
- FIRE vs Semi-Retirement: A Graphical Comparison
