Key Takeaways
- Using Other People’s Money (OPM) comes in to play in things like a matching 401(k) where an employer is matching their money to yours to put away for your retirement.
- There are three leveraging tools in a 401(k): Other People’s Money, pre-tax savings, and tax deferment.
- If your employer offers a matching 401(k), you will save more money for retirement in the long term than you would saving money on your own.
OPM. No, that’s not a new form of yoga! It stands for Other People’s Money, which is money that belongs to a client, customer, or shareholder, not the person using or investing it. In this case, we are looking at money in a 401(k) put in by an employer as a match against salary that you would put away.
When you look at the leverage of this, there are three main tools: Other People’s Money, pre-tax savings, and tax deferment.
The Bureau of Labor and Statistics says that a little over 50% of employers have a 401(k) and that of those, about half of them have a match. The average match offered is 3%. Let’s look at an example of the three leveraging tools in action with a 401(k):
Individual #1 makes $50,000. They don’t have a 401(k), but they save 3% of their salary. That’s $1,500 gross, but you have to pay taxes, and let’s assume taxes are 30%. That means they get to keep 70%, which is $1,050. That grows at 6%, but again, there are taxes, so 70% of 6% is 4.2%. If you take it over 10 years, they grow their assets to $12,724. Not bad.
Now, Individual #2 also makes $50,000 a year, but his employer has a matching 401(k), so he decides to put 3% of his salary away in that, and it is matched 3% by his employer. That money goes in pre-tax, so the full $1,500, and another $1,500 comes from the employer (OPM), for a total of $3,000 a year. It grows, tax deferred, at 6% over 10 years to end up at $39,542. That’s over three times what was saved by individual #1! That’s leverage!
Using these three leverage tools together can help you build your wealth successfully long term.
Until next time, enjoy!
Gary