LAST REVIEWED Apr 09 2020 8 MIN READ
By The Human Interest Team
In the United States, a 401(k) account is considered to be a common retirement plan offered by employers. For a good many companies, an employer-sponsored retirement account option usually includes a 401(k) plan. The purpose of a 401(k) plan is to set aside and invest funds so that upon retirement, you have a nest egg to sustain a positive lifestyle.
Benefits of 401(k) Plans
Employees enjoy several benefits when participating in a 401(k) plan.
For some employees, the employer’s plan allows each employee to contribute a portion of their salary (up to a specified limit) to a 401(k) plan. Other employers go the extra mile by matching the employee’s contribution.
For employees, there’s also a tax advantage. In most instances, the contribution amount is deducted from the employee’s gross income versus their net income.
While an employee’s take-home pay is reduced when the contribution is deducted for the 401(k) plan, the result is at tax time, the reduction in income means a lower tax bill for the Internal Revenue Service. It also means the money deducted is accumulating in an investment account each pay period, building up the employee’s net worth.
People working for a company that matches their employees’ 401(k) contributions can look at the additional funds as a bonus to their retirement savings.
While your money is accumulating in the investment plan, you are in control of how it is invested. This means you choose the investments you want. This includes stocks, mutual funds, bonds, and money market investments. Most of the time, the plans offer a combination of one of these investments.
When the day comes that the money accumulated in your 401(k) is withdrawn that’s when the funds become eligible to be taxed.
How Much Can an Employer Match 401(k) Contributions?
One of the most common questions asked when it comes to 401(k) plans is what is the maximum amount an employer can contribute on a 401(k). The answer is the employer can match up to 6% of the employee’s contribution. This matching amount would be repeated each year, but is subject to change.
How this works out for a 50% match is the employer contributes 50 cents for every dollar you contribute to your 401(k) based on a maximum of 6% of your annual gross income. If your earnings are $50,000 annually and your maximum contribution is $3,000 (6% of $50,000). In this example, your employer matches half that amount, $1,500, so the annual contribution comes out to $4,500.
With a dollar-for-dollar plan, your employer will match your contribution to the plan until you reach the percent limit allowed. For example, a $50,000 salary with a maximum contribution percentage of 5% would allow you to put $2,500 into your 401(k). Your employer would match that figure with its 100 percent match resulting in a contribution of $2,500 for a grand total of $5,000 for the year invested into your 401(k) plan.
Before committing to a plan, it’s important to know how much your employer will be contributing. Discuss this with your employer or someone in your company’s human resources department when you first set up the plan, and every year thereafter, as the contribution amount can vary based on how much your earnings change from year to year.
If you have the opportunity to contribute to a 401(k) plan, it’s in your best interest to do so. An employer-matched 401(k) contribution plan is like getting a bonus every year. If you forego the opportunity to receive a matching amount from your employer, you could be missing out on free money that will let you enjoy your retirement even more or provide you with an emergency fund when you need one.
Disadvantage of Employer Matching 401(k) Contributions
While the money you’ve contributed to your retirement plan is yours regardless of when your employment ends with the company, the money contributed by your employer may be a different story. When you stop working for that company, any contributions your employer has made will most likely be subject to what is referred to as a vesting schedule.
A vesting schedule determines when you can take the contributions by your employer when you leave the company’s employment. There is usually a stipulation stating you must work for the company for a specified period before you’re allowed to remove funds it contributes. Once you reach that period and become fully vested in the company, upon termination, you can take the employer-matched 401(k) investments with you.
401(k) Employer Contribution Limits
For 2020, the Internal Revenue Service has increased the contribution limit for both employers and employees. For 2020, the 401(k) employee salary deferral limit has been raised to $19,500.
The catch-up contribution limit has been increased for the 2020 tax year. This affects employees 50 years of age or older participating in plans. Employees can add an additional $6,500 — referred to as the catch-up contribution — to their maximum contribution limit. The matching contribution by your employer will not be counted towards the plan limit.
The limit set by the Internal Revenue Service for total 401(k) contributions for 2020 from an employee aged 50 or older is $63,500. This figure is the total of the maximum contribution limit of $57,000 plus the $6,500 catch-up contribution. For SIMPLE retirement accounts, the limitation was increased from $13,000 to $13,500.
Those who earn more than $125,000 in 2019 will be considered highly compensated employees for the 2020 plan year. Employees earning more than $130,000 in 2020 will be considered a highly compensated employee for the 2021 plan year.
Considering an investment in a 401(k) plan is a viable opportunity to achieve greater wealth. If you are the owner of a small- or medium-sized business and need information about what’s involved when offering employees a 401(k) plan, contact our staff at your earliest convenience. We have the answers and the experts to take handle all your questions.
The Human Interest Team
We believe that everyone deserves access to a secure financial future, which is why we make it easy to provide a 401(k) to your employees. Human Interest offers a low-cost 401(k) with automated administration, built-in investment advising, and integration with leading payroll providers.