Personal Finance

Money Matters: Why you should participate in 401(k) even if you don’t qualify for an employer match

Q. I just started my first summer job a few weeks ago. I’ll be a high school senior next year and my parents have told me that as long as I attend an in state public university they will pay for my tuition, books, room and board. I’m going to take them up on this and plan to apply only to in-state colleges. If I don’t get accepted, my plan is to attend community college for two years, get good grades and then transfer to a four year college. I’ve read too many horror stories about college graduates in mountains of debt and don’t want to be one of them. Two of my co-workers are recent college graduates, in debt and working for the same pitiful wage as I’m earning. After setting aside some money for gas and some fun, I think I will have an extra $250/week (roughly $3,000 by the time I go back to school) that I will not need.

The company I work for offers a 401(k) plan to which I can contribute after 30 days of employment they offer a nice match of 30 cents for every dollar I contribute. That seems like free money to me and even if I had to take it out before retirement and pay a penalty I think I’d still be ahead. I try to read a lot of financial stuff . I don’t pretend to understand it all but it seems the earlier you save for retirement the better off you will be in retirement. Should I join the 401(k) plan and if not why and where should I put my extra money?

A. Congratulations to you on your summer job and your commitment to adhere to your parent’s restrictions on where to attend college . I’m sure you’ve thanked them for having the financial wherewithal to allow you to graduate debt free, that’s a great gift.

You are correct that the earlier you start investing to reach any financial goal the less money you will need to invest; this is referred to as “time value of money.” Example: One of your financial goals is to have a million dollars in an account by age 65. Assume the achieved rate of return is 10 percent, you begin saving $3,000 a year at age 17 and continue to do so by working summers until you graduate from a four year college. A 17 year old that invests $3,000 each year for the next 5 years and then stops adding to their account ($15,000 total) will have over 1.1 million dollars at age 65. If you wait until age 30 you would need to invest $4,070 each year for the next 35 years ($142,479 total) to achieve the same goal of 1.1 million.

Usually I would suggest that you begin investing in your company’s 401(k) to receive the matching company contribution but I would be surprised if they don’t have a pretty strict vesting schedule. Any company matching contributions may be subject to vesting requirements. Vesting means that if you leave the company before a certain period of employment, you may receive anywhere from 0 to 100 percent of the employers contributions. Legally, after five years of participation in the plan you are always 100 percent vested in all employer contributions to a 401(k). Since this is a summer job, the match is probably not a reason to participate. Look for the vesting schedule in the plan documents or just ask your employer.

Even if you will not be eligible for the matching funds when you terminate employment, there are other good reasons to participate in a 401(k) plan. You will be able to save automatically through payroll deduction and you will defer income taxes on your contributions. When you leave an employer for any reason, you are eligible to take all of your contributions and any vested company contributions with you. To avoid any taxes or penalties these funds should be transferred directly into an IRA or another employer’s qualified plan. If you are not in a high tax bracket (which I doubt) and you won’t vest in any match I suggest you skip the 401(k) and contribute to a Roth IRA.

Contributions to a Contributory Roth IRA can be taken out at any time without taxes or penalties. There is no age or 5-year rule to meet. You can be under or over age 59 ½ and if for any reason, you change your mind, even the very next day, your contribution can come out at any time. Earnings are a different matter. Withdrawals of earnings need to meet some other tests to determine if they are tax and/or penalty free. You can establish a Roth IRA with a no-load (commission free) mutual fund and set up an automated withdrawal from your checking account to the Roth IRA.