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Looking in Depth at the 401(k) Employer Match

By The Human Interest Team

What Is an Employer 401(k) Match?

A 401(k) is an employer-sponsored, tax-advantaged retirement account. Employers can both host employee contributions and make contributions to these accounts. Employer match programs allow employers to make contributions to an employee’s plan based on factors such as the employee’s salary and the employee’s contributions. Many employers match a portion of the employee’s own contributions up to a certain dollar amount or percentage, and this is a powerful incentive for small companies wanting to attract and retain good employees. However, employer matching contributions are optional and at the discretion of an employer. That said, the majority of employers do provide some type of match (86% match, according to the Plan Sponsor Council of America). The average employer match is 4.7% of an employee’s salary.

Once employers set the rules for a match program, employees have guidelines about when and how they can access the plan. These matches form part of an employee’s total compensation package, along with access to a 401(k) account program and other benefits. It is advisable that employees should consider a potential employer’s contribution plan when evaluating a job offer. In fact, 88% of workers say a 401(k) is a must-have when they’re looking for a new job.

For example, a job with a $100,000 salary and an employer 401(k) match of up to 5% of the employee’s salary — $5,000 — is more advantageous than a job with a $102,000 salary and no employer 401(k) match option. Not only do you receive more total compensation, but you also have an additional incentive to invest in your 401(k), which is a great tool for retirement planning and tapping into the power of compound interest.

How Does the Employer Match Work?

Employer 401(k) match programs usually incorporate two figures when calculating a total possible match contribution: percentage of the employee’s own contribution and a percentage of the employee’s salary. Employers might match 25%, 50%, or even 100% of an employee’s contribution up to a set percentage of the employee’s salary.

Some companies may match contributions dollar for dollar, while others match at a smaller percentage. Other employers may set a hard dollar-based cap instead of limiting match contributions to a percentage of the employee’s total salary. Total employer contributions cannot exceed 25% of eligible employees’ annual salary or compensation.

No matter what your company’s match program is, it’s important to strategize. Retirement experts regularly encourage employees to contribute enough to reach the maximum possible employer contribution, or at least as much as they can comfortably contribute. This ensures employees aren’t leaving money “on the table,” especially since it’s part of their total compensation.

Matching Contributions: How Much and When

Whenever possible, it’s a smart strategy to contribute enough to your 401(k) account to “max out” your employer contribution. That means you may need to time your contributions carefully. Just like employers can set their own contribution level guidelines — as long as they comply with Employee Retirement Income Security Act (ERISA) requirements — employers can also decide when in a given year they contribute to your 401(k). However, every company can operate differently. An employer may make regular deferrals or contribute based on an employee’s contributions per paycheck, up to the cap.

There are literally hundreds of matching formulas out there, so contact your 401(k) plan administrator regarding the rules and specifics of the matching formula used by your employer.

The most common matching formula among Vanguard plan holders (a sample representing 5 million people!) was $0.50 per dollar on the first 6% of pay. The second most popular formula for employer matching contributions is $1.00 per dollar on the first 3% of pay and $0.50 on the next 2% of pay.

Here are the most common employer matching formulas:

Match Type Example Formula Percentage of Plans Using This Type
Single-tier formula $0.50 per dollar on the first 6% of pay 71%
Multi-tier formula $1.00 per dollar on the first 3% of pay; $0.50 per dollar on the next 2% of pay 21%
Dollar cap Single- or multi-tier formula with a $2,000 maximum 6%
Other Variable formula, based on age, tenure or similar vehicles 2%

Source: Vanguard

Do employers match contributions right away? Most do. However, some employers require you to work a minimum period of time before starting to match your contribution. In 2018, 24% of Vanguard plans required one year of service for matching contributions.

While you can contribute up to the maximum amount specified by the IRS, you can contribute less. To make the most out of your workplace retirement plan, set the minimum contribution to your plan to reach your employer’s maximum matching contribution.

Let’s calculate what a match might look like assuming you have an annual salary of $50,000:

Employer Match Type Example Your Annual Contribution Your Employer’s Annual Contribution Total Annual Contribution
Single-tier formula $0.50 per dollar on the first 6% of pay $3,000 $1,500 $4,500
Multi-tier formula $1.00 per dollar on the first 3% of pay; $0.50 per dollar on the next 2% of pay $2,500 $2,000 $4,500

Source: Vanguard

By setting your annual contribution to the ceiling of your employer’s matching contribution, as shown in our examples, your annual contribution becomes 50% to 80% larger than if you had only your individual contribution.

In 2018, the average employee contribution to maximize employer match was 7.4% of their annual pay, according to Vanguard data. Your plan rules will dictate the actual contribution percentage to maximize your employer match so contact your plan administrator for more details.

Employer Matching Contribution Formulas

Employers have many options when choosing their match contribution formulas. Four of the most common formulas are:

  • Employers match employee contributions dollar for dollar up to a set dollar amount per employee.
  • Employers match employee contributions at a set percentage of each employee-contributed dollar up to a set dollar amount per employee.
  • Employers match employee contributions dollar for dollar up to a percentage of the employee’s salary.
  • Employers match employee contributions at a set percentage of each employee-contributed dollar up to a percentage of the employee’s salary.

Contribution Limits

The Internal Revenue Service (IRS) limits how much money individuals can have contributed to 401(k)s in their name each calendar year. For 2019, an individual’s 401(k) account can only receive up to $56,000 or 100% of the individual’s salary throughout the year — whichever amount is lower. This amount includes:

  • An employee’s pre-tax contributions (capped at $19,000, or $25,000 for employees over 50 years old, in 2019).
  • An employee’s after-tax contributions.
  • All employer-based contributions.

This $56,000 annual cap applies to individuals whether they hold multiple jobs or change jobs during the year.

Employer contributions do not count towards that $19,000 (or $25,000) tax-deferred cap, but they do count toward the $56,000 total cap.

401(k) Vesting Schedules

Another element in many employer 401(k) match programs is a vesting schedule. Vesting schedules establish how much of an employer’s contributions you own depending on your length of employment. For example, employers may set a vesting schedule of 25% ownership after one year, 50% ownership after two years, 75% ownership after three years, and 100% ownership after four years. If your employment ends before the fourth year, you forfeit the difference. However, that forfeiture only applies to employer contributions; you retain full ownership of any contributions you make to your own 401(k).

There are three general types of vesting schedules:

  • No vesting period, so you retain 100% ownership immediately.
  • A vesting “cliff,” in which you retain 0% ownership until your employment period reaches an established length of time (e.g. wait five years to gain 100% of ownership).
  • Graded vesting gradually grants you ownership over the matched contributions over a period of time (e.g. gain 20% of ownership every year until you get 100% ownership on year five).

If you were to part ways with your employer, you can only take employer contributions that have fully vested. Employer contributions that haven’t vested go back to the employer.

Timing Payments for Maximum Effect

Many employers match their contribution schedule to their employees’ contribution schedules. In other words, any pay period during which you make a tax-deferred contribution, your employer does, too. However, every employer is slightly different, and the plan manager in your company can help everyone optimize their contribution plans to maximize the employer match program.

What If I Have a Roth 401(k)?

Roth 401(k) accounts, like Roth IRAs, accept post-tax contributions, or contributions on which you pay income taxes now but don’t have to pay upon withdrawal. However, many employers will put their contributions in a separate pre-tax, or “traditional,” 401(k) account. Check your plan details for more information.

The Average Employer 401(k) Match Is at an All-Time High — See How Yours Compares

Many retirement professionals recommend that individuals put at least 15% of their annual income into retirement accounts. Employer match contributions reached an all-time high average of 4.7% in 2019, and that can be a powerful incentive for employees. Employers who want to encourage employee retention and good financial planning among their employees can use match programs to help their employees save and attract talented prospects to their company.

If you want to learn more about your 401(k), we’re here to help. Contact our team at Human Interest today to learn about our flexible management tools and how to help your employees save for their retirement.

If you want your company to start offering a 401(k) match program, you can also read our Employee’s Guide to Asking Your Manager or Boss for a 401(k) for Your Company. If you want to encourage them to offer a retirement savings plan, this article may give you a strong foundation to demand a re-evaluation of a matching contribution policy. After all, the better the workplace retirement plan, the more useful it is as a recruiting tool.

Check out our free, online resources to learn more about 401(k)s for you and your company.

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