# Leaving Money on the Table

I spent Sunday helping out my brother in organizing his finances. He joined a major Canadian corporation a little over 11 months ago, and is approaching the point of vesting for his defined contribution pension plan. Within this context, vesting means that his employer will start matching any pension contributions he makes, subject to certain rules and maximums. This is a very common investment vehicle available to Canadians: many companies do not have Defined Benefit (DB) pension plans anymore, opting to provide Defined Contribution (DC) pensions instead. As an incentive for employees to save towards retirement, companies that offer DC plans often provide a “match”. A “match” is a provision wherein the employer will match any contributions an employee makes, subject to certain conditions. For example, one company I know of offers this match structure:

• Match 100% for the first 2% of contributions
• Match 50% for the next 2% of contributions
• Match 25% for the next 2% contributions

In the above, the “2% of contributions” means 2% of the employee’s salary. A more concrete example would be as follows: Assume an individual makes \$40,000/year, and wishes to maximize her employer match. The numbers would add up like so:

Employee contribution %

Employee contribution \$

Employer match %

Employer match \$

2.0%

\$800

100.0%

\$800

2.0%

\$800

50.0%

\$400

2.0%

\$800

25.0%

\$200

As you can see above, the employee contributed \$2,400 of their salary, but the employer contributed \$1,400. This means that the employee received an instant 58% return for doing nothing! This is quite literally free money: your employer is giving you an instant top-up as incentive to save for your own retirement. Let’s take the example a little further: assume someone starts working at age 30, works for 35 years to age 65, and maximizes their contributions every year. Moreover, assume they get a 1% raise every year. If we plot this example over the duration of the person’s employment, the difference—while still a 58% gain—is even more pronounced.

By the end of 35 years, the employee would have contributed \$103,000 on their own, if they had contributed 6% of their salary. But, thanks to the employer match, their effective contribution was \$164,000! They have received an additional \$61,000 all for doing nothing.

However, when an individual contributes to a plan such as the above, they don’t just save the money; they typically invest in mutual funds which are made available to them through the DC plan. We can modify the above graph to show the theoretical balance at retirement, assuming 2%, 4%, and 6% returns on the investments.

Again, there was a 58% gain when you compare the Employee only to the Employee and Employer Match:

 Employee Only Employee + Employer 2% returns \$146,188.44 \$231,464.99 4% returns \$194,337.71 \$307,701.37 6% returns \$322,391.14 \$510,452.58

The astonishing thing is that many people don’t take advantage of the employer match that is offered in their pension plans (here is an interesting read from the Financial Post). This means that there are people who are literally giving up free money. Often some people say that the reason they don’t do this is that they can’t afford to contribute money to their company sponsored pension plan, because that means that they will have less money paycheque to paycheque. To that, I have a couple of comments:

• If you are truly living paycheque to paycheque, then there are more systematic issues at hand that you need to look at; you really need to sit down and plan out a proper budget for yourself.
• You really can’t afford not to take advantage of a pension plan: if you don’t save now, then you will ultimately have to work longer later.
• Contributing to your pension plan is a tax-advantageous activity: meaning that if you wish to contribute \$500 to your DC pension plan, your effective contribution is lower because your taxes will be lower; I will be writing about this in a future blog post.

So there really is no reason not to contribute. Imagine this: you are walking home and there is a fork in the road to go around a building. Both roads from the fork lead you to the same place at the opposite end of the building. From your vantage point, you can see a \$20.00 bill lying on the ground up ahead on the road to the right, and on the road to the left, you can’t see any money lying around. Would you take the fork to the left? Of course not, you would be foolishly ignoring money that was just lying around. Your pension is the same: don’t take the road of no contributions, but take full advantage of the free money your employer is willing to give you.

Onwards and upwards!