Should I Put Money In My 401k If My Company Doesn’t Match
When a company “matches” your 401k contributions, this means they will also contribute to your 401k account in some form or other. In this post, I want to answer the question, “Is it worth it to contribute to my 401k if my employer doesn’t match?”
Here’s how this article is broken down:
- How does 401k contribution matching work?
- Is it worth it to contribute if my employer doesn’t match?
- What about the withdrawal penalty?
- Conclusions and Take-aways
How does 401k contribution matching work?
Here are some examples:
- If you make $100,000 a year and your company matches dollar for dollar up to 10% of your income, they will put in $10000 on top of whatever you put into your account.
- If you make $100,000 a year and your company will match 50 cents for every dollar up to 10% of your income, they will put in $5000 on top of whatever you put into your account.
Usually, the rules for how much a company will match will vary company by company. If your employer does match, you should always contribute to your 401k because your employer is giving you free money. By not contributing to your 401k, you would miss out on that money.
Is it worth it to contribute if my employer doesn’t match?
In order to answer this question, we will look at 2 options:
- Contributing to a Traditional 401k
- Not contributing to a 401k, and, instead, contributing the same amount to a brokerage account
Advantages of a 401k
The advantage of a 401k is that the money you put into your 401k isn’t taxed by the government. The disadvantage is that you can only withdraw your money without penalties after the age of 55. The disbursements, or the money you take out of your 401k when you retire, are taxed as income. This means if you withdraw $100,000 during retirement, you will be taxed as if you made $100,000. If you withdraw $200,000, you will be taxed as if you made $200,000 that year. The good news is you won’t have to pay FICA taxes (social security and medicare taxes).
Advantages of a brokerage account
The advantage of skipping a 401k and putting your money in a brokerage account is that you can withdraw your money anytime and you will only have to pay long-term capital gains tax when withdrawing your money. Today, the long-term capital gains rate in the U.S. is only 15% if you make under $445,000.
We will compare the savings early on to the savings when you retire to see if it’s still worth it to contribute to your 401k if your employer doesn’t match.
Tax Benefits While Your Contributing
When you contribute to a traditional 401k, the money you put in is “pre-tax” and you don’t pay any taxes on it. The 2021 401k limit is $19,500, so we can avoid paying taxes on $19,500.
Let’s say we make $80,000 a year. Because we contribute $19,500 to our traditional 401k, our taxable income drops to $59,500. The chart below shows how much you would save in taxes if you maxed out our 401k based on specific income levels. This includes savings in state taxes, federal taxes, and FICA taxes (for Social Security and Medicare)
| Income | Tax Savings (Approximate) |
| $70,000 | $5500 |
| $80,000 | $6000 |
| $90,000 | $6100 |
| $100,000 | $6100 |
| $120,000 | $6400 |
| $140,000 | $6400 |
| $160,000 | $6400 |
| $180,000 | $6700 |
| $200,000 | $8100 |
If you contribute to your traditional 401k, you stand to save several thousand dollars in taxes. You would pay more in taxes if you decided to invest the money yourself through a brokerage account. Because you pay more in taxes if you don’t use your 401k, you wouldn’t be able to save as much money every year.
Here’s why:
Let’s say you earn $100,000 in income and you contributed the maximum amount to your 401k. You would save $19,500 in your 401k account and have $58,100 in disposable income after taxes. If you didn’t contribute to a 401k, your income after taxes would be $71,500. You would now only be able to save $13,400 in your personal brokerage account if you wanted the same $58,100 in disposable income. Below is a table that shows this:
| Yearly Income | $100,000 | $100,000 |
| Contribution to 401k | $19,500 | $0 |
| Taxable income | $80,500 | $100,000 |
| Your Federal and State Tax Bill | -$22,400 | -$28,500 |
| Income after taxes | $58,100 | $71,500 |
| How much you put in your brokerage account | $0 | $13,400 |
| Income after saving | $58,100 | $58,100 |
You will have the same “income after saving,” but if you used a 401k you would have saved $6100 more at the end of the year. That may not seem like much, but if we compound those savings at 6% a year from age 21 to 55 it’s a big difference.
| Age | 401k Savings | Brokerage Savings |
| 21 | $19,500 | $13,400 |
| 40 | $717,000 | $496,000 |
| 55 | $2,172,000 | $1,504,000 |
By the age of 55, you will have earned about $668,000 more by contributing to 401k compared to opting for a higher paycheck.
Tax Benefits While You Withdraw
When you withdraw money from your 401k, the money is taxed as income as opposed to long-term capital gains. Long-term capital gains are taxed at 15%, so if you withdraw $100k or less per year from your 401k then you will be taxed at the same effective rate as long-term capital gains.
If instead, you opted to put your money in your own brokerage account, you would have to pay a flat 15% long-term capital gains on whatever amount you sell.
Even if you withdrew $200,000 from your 401k a year, which would be an effective 20% income tax, the 401k route would be better. You would pay more in taxes by withdrawing from your 401k, but you would still come out on top compared to a brokerage account because you were able to save more money in the long run in your 401k
What about the Withdrawal Penalty?
You might be wondering, “If I’m going to need the money earlier, isn’t it better to not put my money in a 401k so I don’t have to pay the 10% penalty?”.
Let’s say at the age of 40 you want to withdraw money from your 401k to put a down payment on a home. If you had been maxing your 401k and earning a 6% yearly return you would have $717,000 in your 401k. If you had been saving in a brokerage account, you would only have $496,000. As we discussed above, this is because we would have a higher tax bill by not using our 401k
We need to withdraw $200,000 for the down payment on the home. For a 401k, you would pay a 10% penalty, and then you would have to pay income taxes on the rest. Let’s assume withdrawing from your 401k puts you in a 24% effective tax bracket.
You will only need to pay long-term capital gains taxes of 15% when withdrawing from a brokerage account.
Let’s see how much you need to withdraw to have $200,000 cash in hand and then how much will remain in your nest egg.
| 401k Total at 40 | Brokerage Total at 40 | |
| $717,000 | $496,000 | |
| Withdrawal Amount | $292,400 | $235,200 |
| 401k Early Withdrawal Penalty (10%) | $29,240 | $0 |
| Long Term Capital Gains Tax (15%) | $0 | $35,280 |
| Income Tax (24% Effective Rate) | $63,160 | $0 |
| Total Paid in Taxes + Fees | $92,400 | $35,280 |
| Amount Remaining In Savings | $424,600 | $260,800 |
In the example above, by the age of 40, you will have saved $717,000 in your 401k compared to only $496,000 in your brokerage account. We were able to save more in our 401k and maintain the same disposable income because the 401k offers us tax advantages. We will have to withdraw $292,400 from our 401k since we will have to pay about $92,400 in taxes and feed ($29,240 for the early withdrawal fee and $63,160 in income tax). After this, we will have our $200,000 down payment, and we will have $424,600 left in our 401k nest egg.
If we decided to save everything in our brokerage account instead, we would only have $496,000. We need to withdraw $235,000 to get the $200,000 for our home’s down payment. We only need to pay a 15% long-term capital gains tax, which will be $35,280. Even though we pay less in taxes and fees in this example, we only have $260,000 left in our savings nest egg after our down payment.
If you need to save money for a home or for a business investment, it’s still better to put your money in a 401k and then take the penalty and tax hit for withdrawing the money. This is because we will be able to accumulate more money in our 401k over time and when we withdraw, we will still have more money in our 401k even after factoring in the taxes and fees.
Conclusions
Even if your employer doesn’t contribute to our 401k, it is still a better place to save your money as opposed to a brokerage account. Here’s why:
- When you contribute to a traditional 401k, you’re doing so with pre-tax money. This means you don’t get taxed on the money you’re putting in. This will reduce how much you owe the government in taxes and allow you to save up to $6000 more a year.
- Saving $6000 more every year in your 401k compounding at 6% a year means that from age 21 you will have $6000 more in savings, at age 40 you will have about $200,000 more in savings, and at age 55 you will have about $600,000 more in savings.
- If you need to withdraw money before retirement to buy a home or start a business, you will have more money to withdraw from your 401k. Even after paying the taxes and penalties, you will still have more savings in your 401k than in your brokerage account.
- There may be even more benefits in a Roth 401k option since you don’t pay income tax when you withdraw
- If you use an IRA, there are situations where you can withdraw money without paying a fee; for example, if you’re using the money to buy your first home.