What is 401(k) Matching and How Can You Benefit the Most
A 401(k) plan is the most popular type of retirement plan because it provides a convenient way for employees to save for retirement and flexible contribution options for employers who want to help boost their employees’ retirement accounts.
The most common type of employer contribution is the matching contribution.
A matching contribution is made only for employees who are saving in the 401(k) plan. If an employee is deferring a portion of their paycheck into the plan, the employer matches a portion of the employee’s contribution. If an employee does not contribute a portion of their paycheck into the plan, that employee will not receive an employer matching contribution.
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Benefits of 401(k) matching
Sometimes called free money, employer 401(k) matching contributions are a big win for employees.
All an employee has to do is save a portion of their pay in the 401(k) plan, and their employer will add money to the employee’s 401(k) account. Most retirement planning experts suggest that employees contribute at least enough to qualify for the full employer match. For example, if an employer is matching 100% (dollar for dollar) up to 4% of compensation, an employee would want to defer at least 4% to receive the maximum employer match, so they do not miss out on this free money.
Another benefit of matching contributions is that employees do not have to pay taxes on the matching contribution (and any earnings) until the employee withdraws the money from their 401(k) account.
Matching contributions are also beneficial for the employer. Helping employees retire at a reasonable age with financial security is not only good for employees, but it is also good for employers. Matching contributions can motivate employees to more actively save in the 401(k) plan, setting them on the path to a more financially secure future. The employer also gets a tax deduction for the matching contributions.
Employers also have flexibility in deciding:
There is a lot of variation among employers regarding the amount of matching contributions they make to their 401(k) plan. No set amount is required unless the plan is a Safe Harbor 401(k) plan. Here are some commonly used matching contribution formulas.
Start here to find out what types of matching contribution formulas you can set up in a 401(k) plan with Ubiquity Retirement + Savings.
Employers have a great deal of flexibility in setting up a matching contribution to reward their employees who are saving in the 401(k) plan, but also must meet certain requirements.
Matching contribution formula
A discretionary match allows the employer to decide each year whether to contribute and how much. This can be especially beneficial for newer businesses with uncertain profits. The employer could also select a specific allocation formula (e.g., 100% match on 4% of compensation). This option lets employees know that their employer will be making a matching contribution for the year and may motivate employees to make more substantial salary elections to receive the full match.
The employer may set eligibility requirements that employees must meet before they can receive a matching contribution. For example, many employers require that employees must reach age 21. Some employers also require that an employee be employed on the last day of the plan year to receive the match.
Although employee contributions must be 100% vested, employer contributions, including matching contributions, may be subject to a vesting schedule. A vesting schedule requires an employee to work for the business for a specific timeframe before getting the full amount of contributions made by the employer. Two types of schedules may be used:
A graded schedule grants the employee a percentage of vesting for each year worked for the employer, for up to a maximum of six years. For example: year 1 = 20%, year 2 = 40%, year 3 = 60%, year 4 = 80%, year 5 = 100% ownership in the employer contributions
A cliff schedule grants zero vesting until the employee has worked for the employer for a certain timeframe, up to a maximum of three years. All matching contributions are 100% vested after the cliff is reached. If the cliff is not reached, the employee would not be entitled to any of the matching contributions. For example, under a three-year cliff vesting schedule, if an employee quit working for the business after two years, the employee would not be entitled to take any of the matching contributions made to their 401(k) account.
The most an employee can contribute to a 401(k) account for 2018 (counting employee and employer contributions) is 100% of compensation or $55,000. The maximum that an employer can deduct as a matching contribution is 25% of total compensation of all eligible employees. Only $275,000 of compensation can be considered when calculating an employee or business owner’s matching contribution. So matching contributions cannot be applied to compensation above this limit.
Employer matching contributions are subject to the Average Contribution Percentage (ACP) test, which prevents employer matching contributions made for Highly Compensated Employees (HCEs) from being disproportionately higher as compared to non-highly paid employees. A Safe Harbor 401(k) plan is deemed to pass this test.
The employer can choose to deposit matching contributions on a per payroll basis or at the end of the plan year. Plan contributions must be made by the business tax-filing deadline, plus extensions.
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