The Common 401(k) Mistake That Could Cost You A Fortune

According to the U.S. Census Bureau, 34.6% of working Americans participated in an employer-sponsored, defined-contribution plan — or 401(k)-style plan — in 2020. Among U.S. workers, aged 16 to 64, this type of retirement account was the most common. With this said, many with 401(k) plans aren't maximizing their contributions by taking advantage of employer matching — a common 401(k) mistake that could end up costing you a fortune, especially when you factor in compound interest. By not contributing up to an employer match, you're essentially forgoing free money.

Per CNBC's Your Money Survey, 57% of the 2,700 part- and full-time workers surveyed said they contribute to a 401(k) (or company-based savings plan). Of these respondents, however, less than a quarter (24%) said they saved as much as their employer matched, while 8% said their contribution was simply what the automatic default amount was — which could be lower than what an employer might match, for example, 3% versus 6%. Given how common a financial mistake this is when it comes to 401(k) plans, it's a good idea to check yours to ensure you're getting the most out of this benefit.

How a 401(k) match works

Fidelity, the largest service provider of 401(k) plans in the nation, says more than 85% of its plans offer employer contributions. How much employers contribute varies by company, but per Fidelity's data, the average is 4.8% of an employee's salary; this said, a common formula companies use is 50 cents for every dollar, up to 6% of a person's salary, which comes to 3%. Some companies may mix full matching (100%) with partial matching (50%), too; e.g., matching dollar-for-dollar for the first 2% and then 50 cents for every dollar thereafter up until 5% or 6%.

Another element of the employer match is vesting; it's not unusual for it to take three to five years before an employee gains full ownership of an employer contribution, per CNN Money. However it's calculated, though, or what percentage it might be, an employer match is free money, which is why it's a mistake (a common one) not to take full advantage of it while you can. To do so, you simply need to contribute enough to your 401(k).

Consider, if a person's salary is $80,000, 6% is $4,800. The employer matches dollar-for-dollar on every dollar up to 2%, then 50 cents for every dollar after until 6%. For $80,000, that would come to $3,200 of free money. Combined with the employee's contribution of $4,800, that's $8,000, or 33% more than would have been in the 401(k) without the employer match.

Correcting this common 401(k) mistake

Speaking to Forbes, Jean Young, a senior research associate with Vanguard Investment Strategy Group, said of maximizing 401(k) plans through company matches, "Taking into account the power of compounding and a 6% annual rate of return, contributing enough to receive the full employer match could possibly be the difference between retiring at 60 versus 65."

Of course, everyone's financial situation is different, and so contributing what you can to a 401(k) will always be the best start. However, if you are in a position to start contributing up to an employer match, avoid the common mistake of not doing so, as this could cost you significantly, as discussed. One related mistake people often make, too, is not adjusting their contributions as they earn more.

Even if you miss out on past employer matches, starting right now is a great way to get back on track. What you don't want to do is compound the mistake by not contributing more and getting the match going forward. Also, you can put away more money the older you are. Starting in 2024, a person can save $23,000 per year in salary deferrals (up from $22,500 previously). However, for anyone older than 50, they can add $7,500 more in catch-up contributions for a total of $30,500.