3 Ways You May Be Leaving Free Money on the Table
Believe it or not, there are quite a few ways you can get what is essentially free money, yet a significant number of Americans mistakenly aren't taking it.
Before you read further, no, this isn't one of those get-rich-quick schemes you see on late-night television, nor am I going to tell you to read a 500-page book on how to get grants from the government. These are three very simple and legitimate things you can probably do to boost your income, yet too few people are taking advantage of it.
Have you met your match?
The first area where people are leaving a boatload of money on the table is in maxing out their annual 401(k) contribution. I fully understand that other bills, purchases, and emergencies do sometimes prevent people from maximizing this contribution ($17,500 annually), but you're leaving a lot of free money on the table if you choose not to do so.
First, you get a taxable benefit by making a 401(k) contribution with your pre-tax dollars. In addition, you defer your taxes on potential long-term gains from your investments until you begin making withdrawals from your 401(k)!
Even more important, though, is that a good chunk of employers out there match, to some degree, your 401(k) contributions. Not only does this encourage an employee to save, but it's also a great perk for companies to use to lure in new talent and lower existing employee turnover. Not to mention that 401(k) matches are tax-deductible for the business, so it's in their financial interest to match your contribution up to a certain level.
There are quite a few well-known companies that really do an exceptional job when it comes to matching employee 401(k) contributions.
In the tech sector, IBM matches employees' contributions dollar for dollar -- most businesses only match $0.50 per dollar contributed -- up to 6% of their annual salary. According to BrightScope, which recently ranked some of the top companies in the U.S. with regard to the generosity of their 401(k) plans, there are $42.3 billion in assets under management for IBM's 401(k) plans with 201,400 participants. In other words, that's an average account balance of more than $200,000 per employee!
Another way to look at this, using Bankrate's 401(k) savings calculator and plugging in a few hypothetical figures, is that if you make $40,000 a year and you maximize your contribution up to 10% of your salary beginning at age 30, and IBM matches that contribution dollar-for-dollar up to 6%, by the time you retire at age 65 with the assumption of an annual rate of return of 7%, you'd have more than $900,000. Without that matching employee contribution, you'd be retiring with $344,000 less. That's a lot of money to be potentially leaving on the table!
Pumping up your IRA
The second big mistake that Americans are making is by not maximizing their annual contribution to their Individual Retirement Account, which sat at $5,500 in 2013 (with an extra $1,000 catch-up contribution on top of that if you're over 50), depending on your income level.
There are two types of IRAs, each with their own unique benefits. The first, a Traditional IRA, allows you to take an upfront tax deduction on the total amount you contribute to your IRA in a given year. The downside of the Traditional IRA is that you'll need to pay taxes on your long-term capital gains when you do finally begin taking eligible withdrawals after age 59 1/2.
A Roth IRA, the other type of IRA you can contribute to, offers no upfront tax benefits but can potentially pay enormous dividends for investors that are 10 or more years away from taking their withdrawals. The reason is that money invested into a Roth IRA becomes completely free of taxation. This means if you were able to grow $500,000 into $1,000,000, you'd get to keep every cent of that $1,000,000!
Just imagine if you purchased 1,000 shares of Amazon.com at a split-adjusted price of $3.19, as our co-founder David Gardner recommended on Sept. 9, 1997. Your investment would have spiked from $3,190 to now being valued at $369,170 -- and you'd get to keep every cent of your gains with a Roth IRA as long as you waited until age 59 1/2 to begin taking withdrawals.
IRAs of any form encourage consumers to save, as well as invest in well-run businesses like Amazon for the long run, yet too few people are taking advantage of either of these IRA opportunities.
The final faux pas relates to investors' unwillingness to stick around for the long term. It's not difficult to understand why day-trading is such a common practice these days, as I discovered last week via a large study by three U.S. finance professors showing that between 1999 and 2009, 96% of institutional money managers had completed round-trip trades that lasted less than one month. If the people we expect to be smarter than the average trader are flipping stocks, then why shouldn't the individual investor follow?
Aside from the negative implications when it comes to long-term versus short-term taxation -- which I could very easily make a point for being a fourth way people are leaving free money on the table - investors who are essentially day-trading are missing out on one of the most important factors of compounding growth: dividends.
According to an ABC News report, between 1910 and 2010, dividend yield and dividend growth accounted for about 90% of all returns for stockholders in the S&P 500. But if you're buying and selling without any credence to buy-and-hold, there's a really strong chance you aren't seeing any dividend income.
The great thing about dividends is that they're generally taxed at a lower rate than earned income, and they're a great health marker for a company. Johnson & Johnson , for instance, has paid a dividend regularly since 1944 and has delivered 51 consecutive years of dividend increases. What this tells me is that Johnson & Johnson's cash flow is strong enough to support increasing dividend payments and that its underlying business model must be healthy. Since 1997, each share you've owned of J&J has paid out more than $23 in dividends. If you're day-trading, that's free corporate money you're leaving on the table.
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The article 3 Ways You May Be Leaving Free Money on the Table originally appeared on Fool.com.Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.The Motley Fool owns shares of, and recommends Amazon.com and Johnson & Johnson. It also owns shares of IBM. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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