Date: November 17, 2020

Why People Don’t Participate in Their 401(k) Plans … And Why That’s a Big Mistake

Here’s a shocking statistic: In 2018, almost 30 percent of private sector workers with access to a 401(k) or similar plan did not participate. Here’s another one: About 20 percent of participants don’t take full advantage of their employer’s matching program.

As the founder of Heritage Capital, this boggles my mind. Failure to fully take advantage of a 401(k) is truly a big mistake and can mean a shortfall of hundreds of thousands of dollars at retirement time. Why are many workers, especially younger workers, failing to put enough money into their 401(k)s? Here are a few factors:

  • Ignorance: Younger workers may not fully understand the benefits of their 401(k) plans. This may reflect the fact that personal finance is generally not taught in school, nor at home, where learning concepts like tax-deferred growth and employer matching would be worthwhile. When you are starting to build your career, you understandably may focus your attention on matters more immediate than retirement, which seems a world away. The result is that many younger workers don’t contribute, or contribute enough, to their retirement plans.
  • Priorities: Even if you have a good understanding of 401(k)s, some people have higher priorities for their income. For example, it’s sensible to first build an emergency fund equal to four-to-six month’s expenses. However, it’s all too easy to value current spending over saving for retirement on the belief that you’ll “have plenty of time later.” What’s lost in the process is that even small contributions at an early age can make a big difference decades later when you factor in compounded returns.
  • Inertia: Many workplaces automatically enroll new employees into a 401(k) unless an employee opts out. Unfortunately, automatic enrollment usually involves a very modest contribution rate, such as 2 percent. New employees may figure that their automatic enrollment means they don’t have to think about their 401(k), when in reality, they may be missing out on full employer matching.

Matching Madness

Here’s a tip: Every eligible worker should contribute at least enough to their 401(k) to earn the maximum employer match. Anything less is literally throwing money away. You wouldn’t turn down a raise, so why turn down free money from your employer?

Most 401(k) plans include provisions for employers to match a percentage of employee contributions. A typical plan is a 50 percent match on 6 percent of an employee’s salary. That means you would lose 50 cents for each dollar you underfund the 6 percent contribution level.

That’s not to say that 6 percent is adequate – do you know how much you need to retire? The 401(k) employee contribution limit for 2021 is $19,500, or $26,000 if you’ve reached age 50. Your employer can add money to your account to bring the total contribution to $58,000, or $64,500 after age 50.


Are you on track to reach your retirement goals? Contact Heritage Capital to find out.


The Advantages to Starting Early

The reason to start contributing to a 401(k) early on is to realize the benefits of tax-free growth for as long as possible. Tax-free growth eliminates a significant drag on wealth accumulation, and the impact is greatest when your growth compounds for the maximum amount of time.

Take “Bob” for example. Bob earns $100,000 a year and is eligible for a 401(k) with a 50 percent employer match on up to 5 percent of his salary. Bob therefore contributes 5 percent of $100,000, or $5,000, to his 401(k) each year. His employer’s 50 percent contribution ($2,500) brings the total annual contribution to $7,500. Assuming an average annualized return of 7 percent, Bob can expect his account to grow to $708,000 over the next 30 years.

Suppose instead that Bob contributes only 3 percent of his salary ($3,000) to his 401(k). With the $1,500 employer match, the total addition each year is $4,500. That’s $3,000 less per year, including $1,000 less in employer matching. Over 30 years, the account will grow to $425,000, which is $283,000 less than Bob would earn from a 5 percent contribution.

The $2,000 difference in Bob’s contribution may seem like a lot to Young Bob (it works out to $167 a month), but the power of compounding can turn that difference into a substantial variance in the account’s ultimate value.

Even at 5 percent, Bob’s contribution is the bare minimum. A 15 percent contribution would more than triple the account’s ultimate value, plus it would provide Bob a $15,000 tax deduction each year, unless Bob chose the Roth 401(k) option. Young Bob could contribute up to 19.5 percent of his $100,000 salary to max out the 401(k)s annual benefit.

The Drawbacks to Starting Later – Or Not at All

When you start later, your 401(k) suffers in 2 ways:

  1. You lose many years of tax-deferred growth and current tax deductions, which will result in a much smaller retirement nest egg.
  2. You have fewer years to recover from down markets and investment mistakes. Knowing this may encourage you to adopt an attitude that is overly averse to risk, thereby hurting the account’s overall performance.

Workers who are eligible for a 401(k) and choose not to contribute at all are a real head-scratcher. Does anyone believe they will have a comfortable retirement mainly living on Social Security benefits? Sure, these employees can still contribute to an IRA, but the contribution limit is relatively low and there is no employer match.

Discuss Your Employer’s Plans with a Financial Advisor

If you do anything, talk to a financial advisor about your retirement plan options. A fiduciary financial advisor can help explain the benefits of 401(k) plans and what you could be missing out on by not participating – or by not participating enough. There’s no smarter way to discover the impact of different contribution levels and investment performance on the account’s value over time.

In addition, most plans offer a wide range of investment options, each with its own risk/return characteristics. A financial advisor can show you the impact of these alternatives on your wealth accumulation.

Finally, what we do at Heritage Capital, is we integrate clients’ retirement savings plan with the many other aspects of their financial life. The goal is to formulate a comprehensive set of plans that helps them accumulate, preserve and distribute their wealth in the most beneficial way.

We also help steer clients away from potential mistakes, such as taking money from these accounts early.

Let your 401(k) work for you. Some withdrawals are taxed, while others are not. Early withdrawals may be subject to a 10 percent penalty. The money you withdraw also loses the benefits of tax-deferred growth (unless you roll it over into another tax-deferred account). Even if you just borrow the money and repay it later, you lose tax-free growth on the borrowed amounts.

Stick to your savings strategy now and you’ll thank yourself later when you enter retirement and begin living on a fixed income.

If you’re not currently working with a financial advisor or feel like it might be time to make a change, contact us. Heritage Capital is here to help!

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Paul Schatz, President, Heritage Capital