Matching Contributions

It’s hard to overemphasize the importance of putting at least enough in your employer’s 401(k) or 403(b) plan to earn the full matching employer contribution. But to drive home the point, consider an extreme example.

Suppose your company is likely to have layoffs. Meanwhile, the local employment market is sufficiently depressed that you fear it will take many months to find a new job. Your instinct is to hoard every dollar possible for what could be a lengthy period of unemployment. Nonetheless, if your employer offers a retirement plan with a matching contribution, you would likely be better off funding the plan, even if you fully intend to cash out your savings if you’re laid off.

Let’s say you are in the 15% federal income tax bracket and you put $2,000 in the plan. Your out-of-pocket cost would be $1,700, thanks to the initial tax savings. At the same time, your employer matches your contribution at 50 cents on the dollar, with the matching contribution vested immediately. Result: Your $2,000 investment gets you a $1,000 match, bringing your account balance to $3,000.

If you are then laid off and you cash out your retirement account balance, you might lose 15% to federal income taxes, plus another 10% to the tax penalty for making a retirement account withdrawal before age 59½. That combined 25% hit still leaves you with $2,250, well above your $1,700 out-of-pocket cost. Moreover, if you are unemployed for a long period, you may have little taxable income in the year you cash out your retirement account balance, so your income tax bracket could be below 15%.

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