I want to tell you about a guy who used to work at my current job; we’ll call him Liquid Larry.
Liquid Larry and I talked about money quite a bit. He was pretty frugal, and always preferred to keep as much of his net worth in liquid assets. Every dollar he had to his name was in cash or in a brokerage account somewhere like ETrade.
Any time we talked about personal finance, I would always ask Larry to reconsider his obsession with liquidity. He wouldn’t listen. He was convinced that liquidity is the key to financial prosperity. In fact, he was so convinced of this that he wouldn’t even contribute to our company’s 401k plan, which matches 100% of all employee contributions up to 6% of an employee’s salary.
That means he and I can put 6% of our annual salary in a 40k, and the company will add another 6%. It’s FREE MONEY!
I tried to get Liquid Larry to understand that your 401k is completely liquid if your employer matches 100%. Why? Because you can actually pull every dollar out of your 401k tomorrow, pay all the fees and penalties, and still turn a profit. Let’s look at the numbers to prove it.
Let’s pretend Liquid Larry makes $50,000 a year. That means if he contributes $3,000 (6% of his salary) in pre-tax money to his 401k, the company will add another $3,000 and he will have a total of $6,000 in the 401k account. If he doesn’t contribute $3,000 to the 401k, he will have $2,250 in liquid cash after paying taxes in the 25% tax bracket.
If He Leaves the Money in the Retirement Account
If Liquid Larry doesn’t run into a situation where he needs that money immediately, then he has $3,750 more in his 401k than he would have in his checking account. It is important to remember that Larry will have to pay taxes on the entire $6,000 (plus any interest he earns) eventually, but it’s also important to remember that he already has a 100% return on his original $3,000 investment. There’s no question investing in the 401k with matching is the best option if he doesn’t need the liquid cash.
But what if he needs the money?
If He Cashes Out Early
Maybe Liquid Larry spent last weekend out on the lake. He and some friends rented a boat, and just when the party really started to heat up, they had to return the boat to the rental shop. Bummer. Larry decides he’ll never allow such a tragedy to happen again and wants to buy a boat.
To get the money for this boat, he is going to cash out all $6,000 in his 401k. He obviously hasn’t reached the retirement age yet, so he will have to pay taxes and penalties to get to this money. Specifically, he will pay taxes on all the money at his regular 25% rate, plus an additional 10% for the early withdrawal penalty. That means he has to give the government 35% just to get his money. That’s highway robbery if you ask me.
But wait…
35% of $6,000 is only $2,100. That means Liquid Larry can cash out his 401k, pay all the taxes and penalties, and still have $3,900 left over. If you remember, he only would have had $2,250 in liquid cash if he hadn’t invested in the 401k.
Investing in the 401k with matching and then pulling it out early still results in $1,650 of extra LIQUID cash. That’s a 73% return on investment.
Take the Free Money and Run
If your employer offers 401k matching, it’s simple: max it out. The one thing you’ll want to check is when the money is vested. All 401k money is immediately vested at my company, so once the match is in the account, it’s yours. Some companies require employees to leave the money in the account and stay at the company for a certain number of years before the matching contributions are vested. If your company doesn’t vest immediately, then it reduces the amount of liquidity in your retirement account.
As always, it’s probably best to talk with your HR representative to fully understand how your 401k works. Just make sure you educate yourself so you don’t pass up free money like Liquid Larry did.
Kevin McKee is an entrepreneur, IT guru, and personal finance leader. In addition to his writing, Kevin is the head of IT atย Buildingstars, Co-Founder of Padmission, and organizer ofย Laravel STL. He is also the creator of www.contributetoopensource.com. When heโs not working, Kevin enjoys podcasting about movies and spending time with his wife and four children.
When you put it like that, it seems a no-brainer.
If I had a 401k, I’d be maxing it. ๐
TMG
What do you guys have over there?
I’m glad that you added the last portion about vesting to your post. Also, I think your theory makes sense. I’m sure that buying a boat with the money defeats the purpose of having a retirement account though, but I get your point. I think Liquid Larry is just more comfortable being, well, liquid. I’m pretty sure that his portfolio was doing better than many 401(k)s, that have 100% matching, in 2008. Try your scenario in that time frame. ๐
Well, Liquid Larry and I started working at the same company in 2008. So if he had started investing in a 401k at that point, he really would have had a lot more money today because of the “recovery”. So he’d be doing even better!
Great information and incredibly useful. Thanks for sharing this. I will be getting a match starting next month. I am so excited for the free money.
It’s like a raise! Enjoy it!
Working for a government agency, this is not possible. I wish it were!
Government agencies don’t match retirement account contributions? I thought govt employees always get sweet deals.
I receive a pension, however I pay for it similar to Social Security. 8% of my pay go into the fund and their is a match similar to Social Security. The swhave eet deal is lifetime medical, but I have not had a raise in years. I like to say there is no free lunch!
“Take the Free Money and Run” I like it!
Me too! ๐
I agree completely. I understand the desire for liquidity. I also understand the desire of many person finance bloggers to encourage debt elimination. It is hard to go wrong adding to a matched plan though. As you say making sure that vesting is quick (but it is normally now). Years ago vesting used to be delayed, but it rarely is now other than for options or huge packages for executives (and as we have seen over and over the gold buddies of the CEOs have different rules, even if they are fired they often get all their non-vested stuff given to them).
As you note, even if you have to withdraw it you are most likely, much better off adding to the matched contributions.
It’s just too bad Liquid Larry wouldn’t see that before he left the company. I hope he gets a match and starts contributing at his new job!
Always get the match! It’s free money!
I’ve never understood why people don’t invest in their company’s 401k that matches. The only reason is because the investing options in that 401k are poor.
I really liked this article. Your employer’s, match assuming its vested, is immediate ROI on your investment and even after the early withdrawal fees and taxes you come out ahead- brilliant!
I have a semi-related question. I was always curious as to why a company would provide a matching investment for an employees’ 401K at all? What’s in it for them? I mean, guess I can see that employee benefit part, but rarely do I find someone who swears loyalty to a company for their 401K match. Thoughts?
If the “lowly compensated employees”, defined as employees making under $110k, don’t contribute to the 401k, then the highly compensated employees aren’t allowed to either. The match is in place to encourage the less rich employees to contribute to the plan to ensure the more wealthy employees can contribute the maximum amount.
If liquid larry decided not to contribute, I wonder if he would allow me to pay him to contribute, get my drift? would that be legal? He pays the maximum, then the funds are withdrawn from his 401k acount -the 10% fee transfered to my acount then I deposit everything he contributed plus 1% in the end the gov is getting paid, larry has more money and I have more.