By Eric Rosenberg, WCI Contributor
Building your savings during your residency can be complicated. While many have experienced the benefits of a 401(k) match, they can often be hard to find in residency programs.
In a 401(k) match, your employer will match your contributions to your own 401(k) up to a certain amount. Some employers will match your contributions dollar-for-dollar, while others may contribute half of your initial contributions. No matter what percentage of your contributions are matched, having this extra contribution to your retirement savings can be game-changing.
If your residency program offers 401(k) matching, this is a rare find, and you should consider the benefits carefully. A 401(k) match can make a big difference for your savings in the long run. By building up your savings during your residency, your 401(k) could earn significant interest throughout your career, thanks to your employer’s match.
Let’s take a closer look at 401(k) matching and how it could impact your finances in the long run, especially if you can start while in residency.
How 401(k) Matching Works
According to the Vanguard Investment Strategy Group, most 401(k) matches offered to employees contribute 50 cents for every dollar saved by the employee. As this is the most common kind of 401(k) match, we will use this as an example of how 401(k) matching can boost your savings. For our example of a 401(k) match during a residency, we will assume that a resident has an annual income of $55,000 and a maximum match of up to 5% of their total income.
If you had a residency that met these specifications and you were offered a 401(k) match, the effects on your 401(k) would depend largely on how much you were putting into your 401(k) (the maximum amount for 2022 is $20,500). The amount you would receive from your employer’s match also depends on how much you place into your 401(k). Until your employer meets the maximum percentage of your income, the more you put into your 401(k), the more your employer will give you. It is in your best interests to contribute enough to get the highest match from your employer, as it is practically free money that goes straight into your savings.
If you have a residency that lasts for five years and you place 10% of your income into your 401(k) every year, you would have $27,500 in the account at the end of residency, along with another half of that contribution from your employer, making your new total $41,250. This is the maximum of your employer’s match, as your employer would be matching you with 5% of your total income.
If you kept accruing interest on this balance in your 401(k) during the rest of your career, an interest rate of 2% over 30 years would allow your savings to grow to more than $74,000. This would be how much money you would have from your earnings during your residency alone.
The opportunity for a 401(k) match makes a great deal of difference for your savings in the long term, and it can maximize your benefits if you have a good understanding of your employer’s match.
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401(k) Matching and Taxes
One more key thing about 401(k) management is how they work with taxes. With a traditional 401(k), the money you contribute to your plan comes from your payroll before income tax is taken from your earnings. This reduces your taxable income, serving as a tax deduction for that year. The tax is paid on your 401(k) holdings when you withdraw them, allowing you to postpone certain tax payments.
With a Roth 401(k), your holdings are contributed to the plan after taxes have been deducted, meaning that withdrawals from your 401(k) (and even the interest earned from it) are not taxed. Only some companies offer Roth accounts, but the benefits gained from paying no tax on your investment returns could make them more desirable for some.
Contribution Matching with a Roth 401(k)
While Roth accounts can allow you to earn more money in the long term, they also bring some difficulties regarding contribution matching. With this type of account, matching contributions must be placed in a separate, traditional 401(k) account. This is because the IRS requires employer contributions to be tax-deferred even if the employee contribution was made after-tax into a Roth account. This can make holding a Roth 401(k) a bit more complicated and less desirable.
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Matching with Different Accounts
A Roth account could complicate contribution matching, forcing you to have multiple 401(k) accounts, but it might still be worth it. When choosing between a traditional 401(k) and a Roth account, there are many things to consider. First and foremost, if your residency does not offer support for Roth accounts, then your decision has already been made.
If both options are available, you will at least have a tax-deferred account if there is a match. If you enter into a contribution match, you may need a traditional account to store your employer’s contributions either way. If you are willing to deal with this extra layer to your 401(k) process, the ability to avoid paying taxes on your investment returns could be worth it.
A traditional account could be the right move for you if you need to put off a tax payment on your 401(k) savings. With this approach, you can keep everything in one account for simplicity and defer your tax payments until you are ready to withdraw the funds from your 401(k). However, this setup will require your investment returns to be taxed, and it can cut into your earnings more than you might like.
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The Value of a 401(k) Match
While a 401(k) match might make having a Roth account a bit more complex, the benefits are worth it. With a 401(k) match, you are essentially earning more toward your retirement by simply working toward building your 401(k) yourself. The contributions made by these matches can significantly boost your savings with little to no effort. Turning down a 4o1(k) match would leave free money (i.e. part of your salary) on the table. If you have the opportunity for a 401(k) match, it is practically a no-brainer to go with it.
If you start building your 401(k) during your residency, you will have a good headstart for the rest of your career. The best way to plan for the future is to start early. With an employer contribution match, you will be incentivized and rewarded for building into your 401(k). By beginning to save now, you will experience much smoother sailing when saving for the future.
If you need extra help with planning for retirement or have
questions about the best way to save your money in tax-protected accounts, hire a WCI-vetted professional to help you figure it out.
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