Employer 401(k) Matching: How Does It Work?

Employer 401(k) Matching: Offering a 401(k) matching program as part of your employee retirement plan can be a great way to attract top talent to your company.

• The process by which an employer matches an employee’s contributions to their 401(k) retirement account is known as 401(k) employer matching.
• Employer matching 401(k) plans can boost employee morale and retention, attract better hires, and provide tax benefits to your company.
• You should set employer match contribution limits, review the IRS contribution limits, and include vesting provisions when offering 401(k) matching.

If you’re considering opening retirement accounts for your team, want to improve your existing 401(k) options, or need a new 401(k) plan for a startup, you should set up a 401(k) employer match. But first, you must understand what 401(k) employer matching is, what the benefits are, and how you should run your matching program.

Retirement plans are among the most common benefits provided by employers to their employees. Some employers go above and beyond by providing 401(k) employer matching, which encourages employees to participate in the company’s 401(k) plan by contributing money to their retirement savings based on how much they contribute each pay period.

What exactly is an Employer 401(k) Matching?

The process by which an employer contributes to an employee’s retirement account based on the employee’s contributions is known as 401(k) employer matching. Employers tend to set their 401(k) contribution limits based on the employee’s annual salary. In other words, an employer’s contribution rate is limited to a specific percentage of the employee’s salary. An employer, for example, might be willing to match 50% of an employee’s contribution, up to 6% of their annual salary. So, if an employee contributes 6% to their 401(k), the employer will add 3% to the employee’s retirement savings.

Why should you provide a 401(k) match?

Employer 401(k) matching is a contribution your employer makes to your 401(k) retirement account. The gift matches the amount deducted from your paycheck, usually up to a certain amount. A 401(k) is an employer-sponsored retirement account that allows employees to save and invest for retirement tax-efficiently.

• Better recruiting: Because not every company provides a 401(k) employer match, doing so can help your company stand out to top job candidates. Better benefits are associated with better employees.
• Stronger employee morale and retention: Just as offering 401(k) contribution matching can attract better recruits, it can also improve morale among current team members and increase employee retention at your company.
• Employer tax benefits: Offering 401(k) employer matching can result in tax savings for businesses. Employers can deduct their matching contributions under tax laws.

Is providing an Employer 401(k) Matching required?

Although providing a 401(k) employer match for your employees’ retirement plans may benefit your company, there are no laws requiring it. If you do offer a 401(k) employer match contribution program, you must conduct nondiscrimination testing to ensure that your program benefits all of your employees equally.

These IRS-created tests, known as the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP), ensure that your company’s highest-paid employees benefit as much as your other employees from tax-deferred contributions.

Even if it is not required, the best employee retirement plans usually include matching as part of the retirement fund package. A certified financial advisor can help employers understand the legalities of 401(k) matching as well as the various components of 401(k) programs.

What is the process of Employer 401(k) Matching?

Your contributions to your retirement savings may be matched in a variety of ways depending on the terms of your employer’s 401(k) plan. Employers typically match a percentage of employee contributions up to a certain percentage of total salary. Employers may occasionally choose to match employee contributions up to a certain dollar amount, regardless of employee compensation.

There are two methods for determining how much money you should contribute to your employees’ retirement accounts that are particularly popular:

Some employers will match all employee contributions up to a contribution limit equal to a percentage of an employee’s wages. For example, if you set a contribution limit of 4% of an employee’s annual salary and the employee earns $50,000, you will contribute no more than $2,000 (0.04 x $50,000 = $2,000) over the course of the plan year. It is important to note that if your employee contributes less than $2,000 to their retirement account, you must only match that amount, not the entire $2,000.

As a percentage of an employee’s contributions: Some employers will match a percentage of contributions rather than a dollar amount. For example, if you choose to match 40% of your employees’ contributions with the same 4% contribution limit as in the previous scenario, your employer contribution limit for an employee earning $50,000 per year is not $2,000 over the course of the plan year. It was actually $800.

What is the maximum contribution amount to Employer 401(k) Matching plans?

The 401(k) limit for employee salary deferrals in 2022 is $20,500, which is higher than the 401(k) limit of $19,500 in 2021. Employer matches are exempt from this limit and can be quite generous.

However, the total contribution limit, which includes employer contributions (as well as after-tax contributions if your employer offers them), has increased to $61,000 in 2022, up from $58,000 in 2021.

In addition to these amounts, workers over the age of 50 can make a catch-up contribution of up to $6,500 per year.

The total contribution limit to an employer-sponsored retirement account that a person can make in a year is the sum of elective salary deferrals, employer contributions, and forfeiture allocations. The total contribution limit for 2022 is $61,000; for employees with an annual income less than $61,000, the limit is whatever their income is. Notably, if an employee has a retirement account with your company and a separate 401(k) that they contribute to with side income earned as an independent contractor, the limits on the employer-sponsored account do not apply to the separate account.

What is the relationship between 401(k) vesting and your 401(k) matching program?

According to Fred Egler, certified financial planner at Betterment, “401(k) vesting is the amount that employees are entitled to keep of their matching contributions based on a vesting schedule determined by the employer.”

Your vesting schedule can encourage employees to stay with your company for a longer period of time because the longer they stay with you, the greater their nonforfeitable rights to your employer contributions grow. Your employee can leave your company after a certain number of years and keep all of your employer’s matching contributions, but employees who leave too soon may lose some or all of your employer’s matching contributions.

With graded vesting, you gradually gain access to a larger portion of your employer match. A typical grading schedule looks like this: after one year, you get 0%; after two years, 20%; after three years, 40%; after four years, 60%; after five years, 80%; and after six years, 100%.

Assume you earn $50,000 per year and contribute enough to qualify for your employer’s 6% match. That means you contribute $3,000 to your 401(k) each year, and your employer contributes an additional $3,000. If you leave your job after one year, you will not receive any of the money that your employer has put into your 401(k) (k). If you are 20% vested after two years, you will receive $600 plus 20% of any investment returns earned.

Employer 401(k) Matching contributions makes financial sense

Employers and employees both benefit from 401(k) matching. Employee matching allows employees to maximize their retirement savings while also providing employers with the benefits of investing in their team members’ futures, such as tax savings and reduced employee turnover. In our buyer’s guide, you can learn more about employee retirement plans and their features.

FAQ

How is the Employer 401(k) Matching calculated by the employer?

Employers’ most common partial match is 50% of what you put in, up to 6% of your salary. In other words, your employer will match half of whatever you contribute… up to 3% of your total salary. You must put in 6% to get the maximum amount of match.

What exactly does it mean when an employer matches employee contributions?

Employer matching of 401(k) contributions means that your employer matches a portion of your annual contribution to your retirement savings plan.

What does a 6% Employer 401(k) Matching entail?

This means that the employer will match up to 6% of an employee’s total compensation to his or her 401k account, in addition to what the employee contributes. So, if an employee earns $50,000 per year, the employer’s match is limited to $3,000.

How is the 6% Employer 401(k) Matching determined?

Your employer, for example, may pay $0.50 for every $1 you contribute, up to 6% of your salary. So, if you earn $50,000 per year, 6% of that is $3,000. If you contribute that much to your Employer 401(k) Matching, your employer will match half of it, giving you $1,500 in free money.

Can an employer withdraw their 401(k) match?

Under federal law, an employer may withdraw all or part of the matching funds placed in an employee’s account if the employee fails to remain on the job for the vesting period. Employer matching programs would not exist in the absence of Employer 401(k) Matching plans.