Should You Still Invest in a 401(k) Without a Company Match?

The 401(k) plan may very well be the single best retirement option for the average worker.

If you have a plan available at work, you should absolutely participate in it.

But one of the major reasons people sign up for 401(k) plans is a company match. Employees see it as a way to enhance their retirement contributions.

Some consider the match so important they may refuse to participate if it isn’t offered.

Unfortunately, not all employers with 401(k) plans offer a company match. But if you work for one of the employers who does not offer a company match, should you still invest in a 401(k)?

The short answer:

Yes, but as a secondary option to your own IRA.

Let’s dig into the details of why that’s true. Knowing what they are will help you make your decision.

What is a 401(k) Company Match?

A company match is an employer benefit in which the employer will add contributions to your 401(k), generally based on your own contribution rate.

Company matches can take several forms. The most common is a 50% match up to a 6% of salary contribution by the employee (the employer contributions 3%). Others will do a 100% match, but generally cap it at 3% of your salary.

The company match can be higher, particularly in certain industries where competition for talent is high. In fact, the main reason employers offer a match is to draw talent. In an industry where the match is common, and employer will almost have to offer it just to keep up with the competition.

It’s a powerful benefit, too.

For example, let’s say you contribute 6% of your salary to the 401(k) plan. Your employer provides a 50% match of 3%. That gives you a combined annual contribution to the plan of 9%.

Other important considerations with a 401(k) company match:

Tax treatment of matching contributions

As a tax-deferred retirement plan, you can take a tax deduction for your own contributions to a 401(k) plan.

But since it’s your employer who makes the match, they will get the tax deduction for that portion of the contribution.

Matching contribution on Roth 401(k) plans

An increasing number of employers are offering the Roth 401(k) option.

But if they provide a company match on that plan, the match must go into a traditional 401(k) plan. That’s because the Roth portion must contain only nondeductible contributions.

For that reason, the employer match must be kept entirely separate from the Roth IRA portion.

401(k) Matching Contributions are Subject to Vesting Provisions

Your own contributions to a 401(k) plan are always immediately vested. But the employer match means you must remain with the employer for several years in order to take full ownership of the match.

IRS vesting rules provide two vesting schedules:

1. Cliff vesting – in which the company match is vested 100% after two years, and
2. Graded vesting – in which vesting occurs over six years. For example, after your second year of service, you’re 20% vested; after three years, 40%; four years, 60%; five years 80%; then 100% after six years.

Why do employers require vesting?

We’ve already discussed how employers use a company match to attract talented employees. But vesting schedules are used so employers can keep those employees.

For example, an employer that imposes graded investing over six years is using that method to make sure it’s employees stay put for at least six years.

Understandably, immediate vesting would open the door to employees leaving at any time.

What to Do When You Don’t Get a 401(k) Company Match

Some employees will decline to participate in a 401(k) plan if there’s no company match. This is generally not a recommended strategy. While the match is a nice benefit to have, it’s not the primary reason for having a 401(k) plan.

Even without an employer match, your contribution to the plan is fully tax-deductible in the year taken. That will give you an income reduction for tax purposes of up to $19,500 per year (or $26,000 if you’re 50 or over).

But perhaps even more important is the tax deferral of investment earnings. Taking an example of a tax-deferred investment compared with a taxable investment, you’ll see how important tax deferral is.

Let’s say you have two accounts, each with $10,000. Each will earn investment income of 10% per year. The only difference between the two is that one is a taxable account, and the others tax-deferred.

If you’re in a combined federal and state marginal tax rate of 30%, a 10% return in a taxable account is reduced to 7%. After 30 years, the account will grow to $76,121.

In the tax-deferred account, income taxes have no effect. You’ll earned the full 10% on your investment each year. After 30 years, the account will grow to $174,491.

Do you see the difference? Just as a result of tax deferral, you pick up an additional $98,000 in the tax-sheltered account. And we haven’t even factored in annual contributions!

This is why you should participate in a 401(k) plan, even if it doesn’t offer a company match.

Creating a Retirement Savings Strategy When You Don’t Have a Company Match

Even though you should still participate in a 401(k) plan even without a company match, it may still require a different strategy.

For example, if you do have a company match, the strategy is simple.

You’ll want to maximize your contributions to the plan, as well as to maximize the employer match.

But if there is no match, the following approach is recommended:

Contribute to an IRA first

The reason for the IRA is that you can open a fully self-directed account, with unlimited investment options, and generally with lower fees than an employer sponsored plan will have.

You can contribute up to $6,000 each year, or $7,000 if you are 50 or older for the 2020 tax year. (If you will also contribute to the 401(k) plan, the IRA deduction may be limited based on your income).

Next contribute to your 401(k) plan

Though the plan may have fewer investment options and higher fees than an IRA, it’s main advantage is that it provides a much larger contribution, and therefore a higher tax deduction.

What’s more, you can make both a 401(k) contribution and an IRA contribution (again subject to certain income limits for tax deductibility on the IRA).

That will supercharge your total retirement contributions.

For example, if you contribute $19,500 to the 401(k), and $6,000 to the IRA, you’ll have $25,500 in total contributions and tax deductions.

You should contribute to the 401(k) even if administrative costs and fund expenses are high.

The large amount of potential contributions will more than outweigh the cost of fees over the long run.

That isn’t to say that you should completely ignore fees, but you shouldn’t let them stand in the way of getting as much tax deferral as you can.

Investing Beyond Retirement Plans

Though many people have most or even all their savings in retirement plans, you should always have money invested outside those plans as well.

Part of that is so that you’ll have funds available for purposes other than retirement. But it’s also possible that non-retirement savings can eventually serve as backup retirement plans.

Taxable brokerage accounts

Once you’ve funded an IRA and your 401(k), the next funding target should be a taxable brokerage account.

There’s no tax deduction for contributing to a brokerage account, and no tax deferral on investment earnings. But don’t let that stop you!

Since taxable accounts are not tax-sheltered, you’ll have the advantage of being able to withdraw funds at any time without tax consequences.

That will apply whether you take money in retirement, or well before. Think of it as a tax diversification strategy for retirement. It will ensure you’ll have access to at least some money in retirement without also creating a tax liability.

And like IRAs, taxable brokerage accounts are fully self-directed, and place no limits on your investment options.

An emergency fund

We should have put this recommendation at the very beginning, but this is after all an article about retirement plans.

But whether you save in an IRA, 401(k) or taxable brokerage account, you should always have an emergency fund as a basic foundation.

It will not only provide you with funds in an emergency, but it will also serve an important purpose in your overall investment portfolio.

A well-stocked emergency fund can eliminate the need to liquidate taxable investments or retirement funds in an emergency.

That will enable you to maintain a consistent investment pattern, rather than one broken by periodic crises.

Ideal Size of an Emergency Fund

Final Thoughts

As you can see from the facts above, you should absolutely invest in a 401(k) without a company match.

Between the tax deductibility of your contributions, tax deferral of your investment income, and your ability to accumulate an incredible amount of money for your retirement, a 401(k) plan is well worth participating in, even without the company match.

Sure, when combined with all the other advantages, a company match makes it the perfect arrangement.

But just because it’s less than perfect – and not necessarily by much – doesn’t mean it isn’t good, or even close to perfect.

Forget any reservations you have about a missing company match, and sign up for the plan. But just make sure that you first save money in an emergency fund, and then fully fund an IRA, before making contributions to the 401(k).

Those will help to make up for some of what you’re not getting with the missing company match.