Returns inside a retirement account come from the investments, plus two things outside the market: employer contributions and the tax that is not taken each year.
11 min read · Level 2
I think employer matching is the clearest case anywhere in this Academy of a return that is not a market return, and it deserves to be taught first and loudly for exactly that reason. It is also a good test of whether someone reads the rules of their own financial life: a surprising number of people who spend hours comparing funds have never read the one page of their plan that decides whether they receive free money.
A retirement account can add value in three ways:
Source What it is Employer contribution money your employer adds, often matching yours Tax advantage tax relief on contributions and/or no tax on growth each year Investment return whatever the holdings earn
Employer match. Suppose a salary of 50,000 and an illustrative employer that matches 100% of contributions up to 5% of salary:
You contribute 5% 2,500 Employer adds 2,500 Total invested 5,000
That is a 100% return on your 2,500 the moment it is paid in, before any market movement. Some plans match at 50% or other rates, and employer money may only become fully yours after a vesting period.
Tax advantage. Outside a wrapper, taxes on dividends, interest and gains can reduce returns each year - tax drag. Take 10,000 invested for 30 years at 7%, and an illustrative 1 percentage point annual tax drag in a taxable account:
Inside a wrapper, 7% a year about 76,123 Taxable account, 6% a year about 57,435 Difference about 18,688
The wrapper's value is not just the tax saved each year; it is the growth on that saved tax, compounded over decades.
Because the first two sources are unusually reliable. Market returns are uncertain; an employer match and a tax saving, once the rules apply, are close to certain.
It also explains why passing up an employer match is so costly. There are very few other places where money doubles immediately without market risk.
This is educational information, not investment, securities or financial advice. Rules differ by country and change — get advice from a qualified professional in your jurisdiction before acting.
Educational, not personalised financial advice. Nothing in the Investor Academy is a recommendation to buy, sell or hold anything — what is right for you depends on your own circumstances and the rules where you live.
Sources: U.S. SEC - Investor.gov; U.S. IRS - retirement plans; UK Government - workplace pensions
The match left on the table. An employee earning 50,000 contributes 2% instead of 5%, so the employer, matching 100% up to 5%, adds only 2%.
Employee contributes 2% 1,000 Employer adds 2% 1,000 Employer money not claimed 1,500 a year
Over 20 years that is 30,000 of employer contributions not received - before counting any growth. Invested at an illustrative 5% a year, 1,500 a year for 20 years would have grown to about 49,600.
Treating contributions up to an employer match as optional savings. Contributions that earn a full match are typically the highest-return money most employees will ever invest.
Read the plan documents for the match rate, the salary cap and any vesting schedule.
Check whether your cash flow and other needs allow it, then set contributions at the level that captures all available employer money.
Compare how much tax you would pay each year on the same investments in a taxable account.
When deciding how much to contribute to workplace and personal retirement accounts.
Do not use the illustrative match or tax figures as your own. Plans and tax systems differ, and some employers offer no match at all.
Research published by governments and academic studies of workplace plans in the U.S. and UK found that automatically enrolling employees, with the option to opt out, substantially increased participation compared with requiring employees to sign up. The UK's automatic enrolment programme, introduced from 2012, was reported by the government to have greatly increased the number of eligible employees saving in workplace pensions.
Default settings shape outcomes. Check what yours are rather than assuming they suit you.
Create a free account to read the rest and apply it to your own investing.