Is a 401(k) match contribution tax-deductible?

The tax benefits of employee contributions to a 401(k) plan may be well-known. The money an employee puts into a company-sponsored retirement plan is either taken out of that year’s taxable income (in the case of a traditional plan) or withdrawn tax-free (in the case of a Roth). 

Offering a 401(k) plan can help your company attract top talent as well. Employees look for companies that offer strong benefits packages—and that includes retirement plans. Even better, there are a number of ways to help your employees meet their retirement goals while keeping the costs of the plan affordable.

Many employers match a portion of the employee’s contribution, giving them an extra boost toward their retirement. This offers tax advantages to both the employees and the employers (we’ll discuss the details below). However, this is where the tax implications get a little murky: can employees deduct employer contributions alongside their own? Can companies reduce their own tax bills by making matching contributions?

Below, we explore the tax implications of using matching contributions in a 401(k) plan from both an employee and employer perspective to help clear the air. 

What is a 401(k) match?

Employees can contribute up to $23,000 to their 401(k) in 2024, or up to $30,500 if they’re over 50 years old (see 401(k) contribution limits). Employers may choose to design their 401(k) plan to include a match on these employee deferral contributions. It is uncommon for an employer to match 100% of employee contributions dollar for dollar. A match formula on up to 6% of deferrals is common. 

How do match formulas work?

Match formulas can be structured in several ways. They may be based on plan year compensation or on pay period compensation. Employers may match 100% of the amount deferred, up to a maximum threshold, in the stated time period or some smaller percentage such as 50% (up to 6% generally, as stated above).  

If a match formula is based on deferrals made in the pay period, the employee will only receive a match in pay periods in which they make a deferral. Depending on how much they contribute per pay period, the employee may “leave employer match on the table” and not get the benefit of the full match. For example: 

• The match formula is “100% match on deferrals up to 6% of pay period compensation.” Assume an employee makes $52,000 per year in compensation and is paid $1,000 per pay period for 52 pay periods.  

  • Scenario 1. If the employee elects to defer 6% per pay period, they will defer $60 per pay period (6% x $1,000) and will receive a matching contribution of $60 per pay period (100% of first 6% deferred). If the employee continues to contribute 6% per period for the full year, they will have deferred $3,120 and received a total of $3,120 in matching contributions.

  • Scenario 2. If the employee elects to defer 15% per pay period, they will defer $150 per pay period (15% x $1,000) and will receive a matching contribution of $60 per pay period (100% of the first 6% deferred) , which is the maximum match per pay period. The employee does not receive any match for deferrals over 6% of compensation in the pay period.  If the employee stops deferrals after 30 pay periods they will have deferred $4,500 and received $1,800 in match for the year. They are not entitled to any additional match. Even though the employee actually deferred more than the employee in Scenario 1, they did not collect the full matching contribution for the year.

If a match formula is based on deferrals for the plan year, the employee will receive the full matching contribution if they reach the maximum deferral amount for matching based on plan year compensation. These formulas benefit employees who defer larger percentages of compensation early in the year.  However, they are more expensive for employers because they often require the employer to make a “true-up” contribution at the end of the year. For example: 

• The match formula is “100% match on deferrals up to 6% of plan year compensation.” Assume an employee makes $52,000 per year in compensation and is paid $1,000 per pay period for 52 pay periods.  

  • Looking back at Scenario 1 from above where the employee deferred 6% per pay period for the full year, the employee is not entitled to any additional match based on the plan year formula. The maximum amount of deferrals that will be matched for this employee is $3,120 (6% X $52,000). Since the employee received matching contributions of $3,120, no true-up contribution is required. 

  • Looking back at Scenario 2 from above where the employee deferred 15% per pay period for 30 pay periods, the employee actually deferred $4,500 for the plan year which is more than 6% of plan year compensation. Since the employee actually contributed the required 6% based on plan year compensation, they are entitled to a true-up contribution. The true-up contribution is the difference between the amount of matching contributions the employee received ($1,800) and the maximum match under the formula ($3,120). The true-up contribution for this employee is $1,320. 

401(k) matching contributions can be one of the most valuable benefits options you can offer employees who are focused on saving for their retirement.

What matched 401(k)s mean for employees claiming tax deductions

First, let’s break down the two types of employee contributions that can be made to 401(k)  plans: traditional (pre-tax) and Roth. Traditional (pre-tax) deferral contributions are deducted from the employee’s taxable income for the year. The deferral contributions grow tax-free in the 401(k) plan and are subject to taxes only when withdrawn. Roth deferral contributions are the opposite: deferral contributions are made from after-tax money and are not taxed (again) when withdrawn. Earnings on Roth deferrals can also be withdrawn tax-free if certain requirements are met. Here’s an example. Let’s say the employee’s salary is $90,000, and they contribute $10,000 to their 401(k).

• If the employee deferral contribution is pre-tax, their taxable income for the year is just $80,000.

• If the employee deferral contribution is Roth, their taxable income for the year is still $90,000.

Now, let’s say the employee retires, and withdraws $60,000 from the 401(k).

• If the employee deferrals were pre-tax, the full $60,000 withdrawal is included in the employee’s taxable income for the year. If the employee deferrals were Roth, $0 is included in the employee’s taxable income for the year (assuming the withdrawal is made after earnings are also eligible for tax-free distribution). 

If an individual's current income is higher than what they anticipate their income will be after retirement, pre-tax deferral contributions are most beneficial.  However, if an individual's current income is lower than what they anticipate their income will be after retirement, Roth deferral contributions may be the better option. Individuals should discuss their retirement savings strategy with a qualified financial advisor. 

Is a 401(k) match taxable?

Yes. According to the IRS, employer contributions are deductible on an employer’s federal income tax return, as long as contributions don't exceed limitations in section 404 of the Internal Revenue Code.

Employer contributions are always taxed when withdrawn. This is because employer matching contributions are always made on a pre-tax basis. This is true whether the employee is deferring on a pre-tax or Roth contribution basis. 

Can companies deduct 401(k) matching contributions from corporate taxes?

Employers can deduct matching contributions up to a maximum limit from their corporate tax returns. The maximum deduction for all employer contributions (i.e., match and profit-sharing contributions) to a 401(k) plan is 25%  of the compensation paid during the year to eligible employees. 

Credits for setting up retirement plans

If you’re a small business and want to implement a retirement plan, you may be eligible for the Credit for Small Employer Pension Plan Startup Costs. Your business might be eligible if it:

• Has 100 or fewer employees who were paid at least $5,000 in the preceding year,

• Has at least one plan participant who is a non-highly compensated employee, and

• Hasn’t offered a retirement plan to the same employees in the past three years

Qualifying businesses can receive a credit for up to 50% of startup costs, up to $5,000 a year for three years (for a total of $15,000). The credit can be used to offset expenses needed to set up, administer, and educate employees about the plan. (Note: You aren’t allowed to claim the credit and deduct those same expenses.) In addition, an eligible employer that adds an auto-enrollment feature to their plan can claim a tax credit of $500 per year for three years beginning with the first taxable year the employer includes the auto-enrollment feature.

Benefit of matching contributions for employees 

401(k) matching contributions can be one of the most valuable benefits options you can offer employees who are focused on saving for their retirement.

Adding or increasing matching contributions may in some cases be financially better for both employees and employers than a pay raise is. When an employee receives a raise or bonus, they pay income and employment taxes on the money. The employer will also owe Social Security, Medicare, unemployment, and other taxes on the payment. The average worker faces a 22.4% tax burden, and the average employer an 8.9% tax burden. All told, a $1,000 bonus ends up costing employers an average of $80, while putting only $776 in employees’ pockets.

On the other hand, if the employer makes an additional $1,000 match to the  401(k) plan, the employee still pays FICA taxes but income taxes on that $1,000 are deferred until withdrawn. The employer will also benefit from reduced tax obligations. 

Offering a 401(k) plan does more than lower corporate tax bills

In addition to tax write-offs for setting up and contributing to retirement plans, offering a 401(k) plan provides indirect financial benefits. Employers often hear that retirement plans help lower recruiting costs, increase productivity, and cut down on turnover — and the data backs up this claim.

For example, researchers at Boston College found that states that reduced pension benefits had a diminished ability to “maintain a high-quality workforce.” Opinion surveys agree: 41% of small businesses offering a 401(k) cited attracting and retaining workers as a key motivator, according to a survey by Wakefield Research and Capital One ShareBuilder 401(k).

There’s another, more personal benefit to offering retirement plans. The company owner may also participate in a 401(k) plan. In fact, the Wakefield survey found that 39% of small business owners cited personal benefits as a reason they offered retirement plans. By helping your employees save for retirement, you’re also building your own nest egg.

Can small businesses afford to offer 401(k)s?

That same Wakefield Research survey found that 23% of small business owners don’t offer a 401(k) plan because they can’t afford to match contributions, and 29% said they would consider offering one if plan costs fell. Traditionally, offering a 401(k) has been considered expensive for small businesses – but not anymore. It’s no longer necessary to spend thousands of dollars to implement a 401(k) plan.

Related article: How Much Does a 401(k) Cost Employers?

Technology can be used to automate the manual maintenance required by traditional 401(k) plans. This not only reduces costs, it makes upkeep more manageable for small businesses. For example, providers can integrate with payroll providers to sync employee data and process contributions. Or, they can design tools that help streamline participant enrollment and onboarding, to handle much of the heavy lifting required by 401(k) plan administration.

Both employers and employees receive tax benefits for contributing to a matched 401(k) plan. Employees can build their nest eggs tax-free, while employers enjoy tax credits and write-offs, lower employee turnover, and a more productive workforce. If you’re a small business, a low-fee retirement program can benefit your employees and your bottom line.

Please visit our Learning Center for other great resources on 401(k) essentials.