Small to mid-size companies can offer creative and customized options when it comes to retirement benefits (see 401(k) for small businesses). These businesses can focus on setting up specific programs that meet their business needs while also serving to engage their employees. One important offering is a 401(k) retirement plan for employees to invest in. Ideally, an employer would be in a financial situation to make some type of company match for employee’s contributions. However, if the company’s financials can’t support ongoing matching contributions, there are other options.
One option is a discretionary contribution. As described by the IRS, “If the plan document permits, the employer can make contributions other than matching contributions for participants. These contributions are made on behalf of all employees who are plan participants, including participants who choose not to contribute elective deferrals.”
Employers can choose to make discretionary contributions but they are not required every year. They might opt to make contributions based on business performance, or as a way to reward employee performance.
How does a discretionary 401(k) contribution work?
If the plan document allows, an employer can make contributions other than matching contributions on behalf of all employees who are plan participants.
Why make a discretionary contribution?
There are many reasons an employer might consider making a discretionary contribution, including:
- Positively impact employee engagement, as this contribution isn’t something they’re expecting.
- Avoid over-committing to an employer match with a budget-friendly way for small businesses or startups to make a contribution to employees’ 401(k) plans without the commitment of having an ongoing, established company match.
- Utilize the 401(k) tax benefits which, as with any 401(k) contribution or match, exist for both the employee and employer (see 401(k) benefits for employers).
- Motivate and incentivize employees based on organizational performance. Based on business results, an employer may opt to make a “profit-sharing” discretionary contribution to all eligible employees, regardless of whether the employees are regularly contributing to their 401(k) investment or not. The most common approach for this type of profit-sharing is a one-time, end-of-year contribution. After the year ends and you figure out your company’s earnings, decide how much you want the company to contribute to each of your employees’ retirement savings, and then make that contribution by March 15th for the previous year.
Related article: How Much Does a 401(k) Cost Employers?
Discretionary 401(k) match contribution rules
According to the IRS, contributions to all accounts (elective deferrals, employee contributions, employer matching and discretionary contributions and allocations of forfeitures) may not exceed the lesser of 100% of employee compensation or $57,000 for 2020 ($63,500 including catch-up contributions). This is something to be aware of as you consider making any discretionary contributions, especially regarding non-discrimination testing and the contribution limits for highly compensated employees.
If you’re wondering whether or not it’s worth it, take a look at positive company reviews on Glassdoor reviews about company retirement benefits. You’ll see comments indicating how a 401(k) can signal to employees that a company is invested in their future:
“The company would add a ‘bonus’ employer contribution every year based on the profits made by the company.”
“They match up to the first 5% an employee contributes to their 401(k) and then make a discretionary contribution once a year.”
”It’s a medium match, but they make an annual discretionary contribution.”
These examples are from three random companies, but they serve to illustrate that a discretionary contribution makes a difference for employees. While these contributions aren’t guaranteed and therefore aren’t as likely to encourage employee participation as a regular company match, they do allow employers to contribute to the plan for their employees whenever they can.
Liz Sheffield has more than a decade of experience working in HR. Her areas of expertise are in training and development, leadership development, ethics, and compliance.