Are you missing out on free money?
“A dollar saved is two dollars earned.” – David Chilton ( from ‘The Wealthy Barber’)
A couple of weeks ago, I posed the following question to a group of employees:
“If I could turn $110 per pay into $8476 a year. 100% guaranteed. No risk. No catch. Would it make sense to do it?”
Not surprisingly, every person in the room agreed that handing over $2860 in order to get $8476 would be a good trade – a guaranteed 296% return is hard to turn down!
I went on to explain to the group that an employee making $85,000 a year could put up to 5% of their earnings into their group retirement account and that their employer would match 100% of that contribution (free money). They had the added benefit of being able to contribute to their group retirement plan via payroll deductions with before-tax dollars which meant they would get the tax benefit directly on their paycheque. In a nutshell, it looks like this:
- Each paycheque the employee contributes $163 (5%) to their retirement account
- The employer matches their $163 contribution
- A total of $326 per pay goes into their account.
- The employee gets $52.16 in tax savings directly on their paycheque (32% of $163)
- This tax saving means that their net pay is only reduced by $110.84
Related article: Principles of saving money
The money was immediately vested which means that even if the employee left the company after a few months of employment, all of the money in their account (their contributions and the employers) would belong to them. If they chose to invest the money then their returns could be even higher.
Assuming that a reduction in their take-home pay of $110 per cheque was something that wouldn’t leave them in a difficult situation financially, it made absolute sense to those employees to sign up for the plan.
If your employer offers a workplace savings plan and you haven’t yet signed up, maybe it’s worth doing a little research into how to get that free money. Here are some things to consider:
Know your plan
Your group plan will have a member booklet that details the type of plan(s) offered (Pension, RRSP, TFSA, etc.) and the rules regarding joining, contributing and withdrawing money from the plan. Usually, there is a minimum amount of time that you have to be employed before you can join the plan and the maximum amount that the employer will match your contributions. Some plan allows employees to withdraw money while they are employed (taxes apply) while others prohibit withdrawals unless the employee leaves the company or retires. Some pension and DPSP plans require you to be a member for a certain amount of time until the employer contributions actually belong to you (this is known as the vesting period). There is no vesting period with group RRSPs.
Figure out your contribution amount
Just because your employer will only match your contributions up to a certain percentage, doesn’t necessarily mean that you should only contribute that amount. When you consider that most personal finance books suggest saving a minimum of 10% of our gross earnings for retirement, it makes sense to view the employer contribution as a “top-up” of our own savings and to save as much as we can, regardless of the percentage that’s eligible for the matching.
Are your payroll deductions before or after-tax?
If you’re contributing to your group plan with before-tax dollars, you’re getting the tax benefit directly on your paycheque. For someone in a 32% tax bracket, this means that they could direct $150 to their group retirement account and, because they would save approximately $50 in taxes, their net pay would only be about $100 less.
Related article: Understanding Marginal Tax
When we think about how much we can afford to save we tend to think in terms of net dollars (the amount that we take home) versus the gross amount that we make before deductions. If your employer has their payroll set up for before-tax contributions this could make a significant difference to the amount you’re able to save.
Who makes investment decisions?
Most group plans allow employees to decide how their contributions and employers are invested. Some plans don’t allow members any control over the investment decisions and some only allow control over the employee portion of the account. Make sure you check your plan’s member booklet to determine who controls the investment decisions before you enroll.
At the end of the day, unless your workplace savings plan is mandatory, no-one can require you to enroll in it but if you have the option to sign up for a plan that allows you to contribute before-tax dollars and/or offers a matching incentive then, for the vast majority of people, it makes sense to sign up.