Everyone always says that you should contribute to your 401(k) in order to get the match and then go with a Roth IRA because it’s free money. I agree with the first part of that statement, but I don’t agree with the idea that the matching money is free money.
Think about it for a moment. Why would your employer give you free money? If you look at your net worth statement for the year, it looks like this:
- + gross wage income
- – income and paycheck taxes
- – 401(k) contribution (since it comes off your paycheck)
- + 401(k) contribution (since it’s deposited into your 401(k) investment account)
- + 401(k) matching from your employer (since it’s deposited into your 401(k) investment account)
- – monthly bills and spending that doesn’t come off your paycheck
- + interest and dividend income
So if the 401(k) matching amount is a positive change in your net worth, as is your gross wage income, then isn’t it income for the year?
My total compensation for the year can be summed up as follows:
- My monthly salary
- Cash bonuses
- Referral bonuses
- Stock grants and bonuses
- 401(k) matching contributions from my employer
- Interest and dividend income
The 401(k) matching amounts that your employer contributes on your behalf aren’t free money, but money that they expected to give you. In not contributing enough to your company’s 401(k) plan each month, you are essentially taking a salary cut. For example, if they contribute 5% of your gross salary to the 401(k) plan on your behalf, then you are taking approximately a 4.76%* salary cut by not taking advantage of that.
Next to debate: Are employer contributions to an HSA or similar account for healthcare “free money” or “hidden compensation”?
Disclaimer: I still wholeheartedly think that you should contribute, at the very least, enough to your 401(k) to get the match – I only disagree with calling the matching contributions “free money”.