The Various Benefits of Employer Matching in 401k Plans

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Retirement plans are a pretty common perk that employers offer their teams. Some go the extra mile with 401(k) employer matching, which is basically a way to encourage employees to join the company's 401(k) plan by adding extra money to their retirement savings based on how much the employees contribute each pay period. If you're considering setting up retirement accounts for your staff, improving your current 401(k) options, or need a new 401(k) plan for a startup, you might want to think about adding a 401(k) employer match. But before jumping in, you should really get a good grasp of what 401(k) employer matching is, the benefits, and how to run the matching program.

401(k) Employer Matching Description

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It's when an employer adds to an employee's retirement account based on what the employee puts in. Usually, employers set their 401(k) contribution limits based on the employee's yearly salary. For instance, an employer might match 50% of what an employee contributes, up to 6% of their annual salary. So if the employee puts 6% of their salary into the 401(k), the employer would kick in an extra 3%. Sometimes, though, employers set a matching limit based on a specific dollar amount rather than a percentage of the salary. Either way, these contributions usually show up on the employee's paycheck each pay period.

401(k) Vesting Relation to Matching Program

Basically, as an employer, you can take ownership of some or all of your employer match contributions through something called vesting. Legally, vesting means you have the right to ownership over a future payment, benefit, or asset. In terms of retirement accounts, vesting is the process where employees earn more rights to access their employer contributions over time. That's why the vesting schedule you set for your 401(k) employer match is super important. Your vesting schedule can motivate employees to stick around longer because the longer they stay, the more rights they gain to your employer contributions. After a certain number of years, an employee can leave and take all of your employer's matching contributions with them, but if they leave too soon, they might lose some or all of those contributions.

On the flip side, offering immediate vesting is a great perk for employees too. They'll feel secure knowing that if they leave your company for any reason at any time, their 401(k) funds go with them no matter how long they've been with you. This option can make your business more attractive to new hires.

Maximum Contribution Amount to 401(k) Plans

When figuring out how much to contribute to an employees retirement account, you should also think about the annual contribution limits set by the IRS for both you and your employee. For 2022, the limit on elective salary deferrals for the contributions an employee chooses to make is $20,500 for a traditional 401(k) plan. For a SIMPLE 401(k) plan, this limit drops to $14,000. Employees who are 50 or older can add an extra $6,500 in elective salary deferrals to a traditional 401(k) plan or $3,000 to a SIMPLE 401(k) plan.

The total contribution limit to an employer-sponsored retirement account in a year includes elective salary deferrals, employer contributions, and allocations of forfeitures. For 2022, this total limit is $61,000; for an employee with an annual income below $61,000, the limit is whatever their income is. Interestingly, if an employee has a retirement account with your company and a separate 401(k) they contribute to from side gigs as an independent contractor, that separate account isn't affected by the limits on the employer-sponsored account.

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Amount for 401(k) Contributions

Employers 401(k) match amounts can vary a lot. However, all contribution limits and withdrawal rules have to follow the Employee Retirement Income Security Act. Other than that, you can set your 401(k) contribution rates however you like. There are two common ways to decide how much to put into your employee's retirement accounts:

• As a percentage figure of an employee's contributions: Other employers match a percentage of the contributions instead. For example, if you match 40% of your employee's contributions with the same 4% limit as before, then for an employee with a $50,000 salary, your limit isn't $2,000 over the year. Instead, it's $800 (0.4 x $2,000 = $800).
• As a percentage figure of an employee's wages: Some employers match all employee contributions up to a limit based on a percentage of the employee's wages. For example, if you set a limit of 4% of an employee's income and they make $50,000 a year, you'll contribute at most $2,000 (0.04 x $50,000 = $2,000) over the year. If your employee puts in less than $2,000, you only match that amount, not the full $2,000.

401(k) Matching Mandatory Rules

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401(k) matching works by putting an employer contribution into an employee's 401(k) account. For your 401(K) match program to work well, you need to think about a few questions. While offering a 401(k) match for employees retirement plans can be good for your business, there are no laws that say you have to do it. But, if you do offer a 401(k) match program, you have to do nondiscrimination testing to make sure it benefits all your employees equally. These IRS tests, called the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests, ensure that your highest-paid employees benefit just as much from tax-deferred contributions as everyone else.  Even though it's not required, the best employee retirement plans usually include matching as part of the package. A certified financial advisor can help employers understand the legal stuff around 401(k) matching and the different parts of 401(k) programs.

Reasons to Offer a 401(k) Employer Match

Offering a 401(k) employer match with your small business 401(k) plan has three key perks for your company:

• Employer tax advantages: There are tax savings businesses can get by offering 401(k) matching. Tax laws allow employers to claim their matching contributions as tax deductions.
• Stronger employee retention and morale: Just like it can attract better recruits, offering 401(k) matching can boost morale among current team members and help keep employees around longer.
• Better recruiting chances: Not all companies offer a 401(k) match, so doing this can help your business stand out to top job candidates. Better benefits usually mean hiring better employees.

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Conclusion

401(k) matching makes financial sense for both employers and employees. It's the best way for employees to maximize their retirement savings, while employers get benefits like tax savings and lower employee turnover.

Frequently Asked Questions

Q: How do Roth 401(k) matching contributions work?

A: When employers make matching contributions to a Roth 401(k), the money goes into a separate traditional 401(k) account, not the Roth account. This is due to the tax treatment of Roth funds.

Q: What is an example of 401(k) matching?

A: Suppose an employee earns $50,000 annually and decides to contribute 10% of their pay to their 401(k) account, or $5,000 per year. If the employer matches 100% of employee contributions up to 6% of salary, the employer would match $3,000. If the employer made a 50% match, the match amount would be $2,500. For more examples and potential growth over time, check out this 401(k) matching infographic.

Q: Is a 401(k) worth it with matching?

A: Every employee has to decide if a 401(k) plan is worth it based on their unique financial situation. However, an employer match usually makes it more attractive to participate and contribute enough to get the full match.

Q: What does a 6% 401(k) match mean?

A: This means the employer is matching up to 6% of an employees overall compensation to their 401(k) account on top of what the employee is contributing. So, if an employee is earning $50,000 per year, the employers match would not exceed $3,000.

Q: What is considered a good 401(k) match?

A: The best 401(k) match would be a 100% match up to the allowable limits. But any match is good since it's essentially free money.

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