401(k) Matching Contributions

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.