The Advantages of The Employer Matching 401(k) Contributions
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In a mutual fund 401(k)that you have through work, you notice that for every dollar you invest, your company also invests a dollar. (You are able to invest up to 5% of your annual income, and your company has a 5% match.)
What return on your investment does this represent? What does your answer suggest about matching programs?
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Solution Summary
In this solution, I discuss why it always good for an employee to take advantage of a 401(k) if an employer matches at least part of his or her contribution.
Solution Preview
As the problem states, for every dollar you invest, the company invests a dollar. Thus, if you invest $1, your account increases by both your $1 and the $1 matched by company. Your account has increased by $1 (the company match) for your $1 out of pocket investment. (Note that an employee need not pay income taxes on his or her employer's contributions to the employee's 401(k) account, so the employee benefits by the amount of the entire contribution.) The return on an investment is computed by dividing the amount returned (or gained) from making an investment by the amount invested. In this case,
Return on Investment=Amount Gained by Making Investment/Amount Invested.
Return on Investment=$1(company match)/$1 (your investment), or 100%.
This suggests that matching ...
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