How Does 401(k) Employer Matching Work?
A 401(k) is the standard retirement plan offered by companies across the nation as part of their employment benefits package. Many of those employers also offer what’s known as a matching contribution as an added benefit. Matching means that the employer contributes a specified amount to the employee’s retirement plan based on (i.e., matching) the employee’s annual contribution.
Why would an employer give money away? Well, there are three valuable benefits employers can derive from small business 401(k) matching:
- Increased employee retention and morale
- The ability to attract and retain top talent
- Significant company tax incentives
How much can employees contribute to a 401(k)?
For 2022, employees can contribute a maximum of $20,500 per year and an additional $6,500 for people aged 50 or older. Keep in mind that employer matching contributions do not count towards this contribution limit. However, there is a limit for employer and employee contributions combined (if you are the business owner and are contributing as both the employer and employee): $61,000 or 100% of your salary, whichever comes first.
The average 401(k) match in 2022 was 6%. Specific terms of a 401(k) retirement plan can vary. Some employers use a very generous matching formula while others choose not to match employee contributions at all. Note that not all contributions to your employees’ retirement plan are due to matching. The plan document will contain details on how your company’s 401(k) works.
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Types of company matching contributions:
- Partial matching
Partial matching means that the employer matches part of your 401(k) contribution, up to a specified amount. For instance, many employers offer a 50% match of the employee’s contribution, up to 6% of their salary.
- 100% (full) match
Full 401(k) matching as a dollar-for-dollar match where the employer puts in the same amount of money the employee does – up to a specified amount. For instance, if the employee put in 4%, you as the employer contribute 4%. However, if the employee contributes 6%, you will still only need to contribute 4%.
401(k) vesting schedules
It is essential to understand the plan’s vesting schedule, which refers to how much of an employer’s contributions belong to the employee. This is usually based on how long the employee has worked at the company.
This means that the employee may forfeit their employer’s match if they are terminated or leave before a specified number of years. In other words, if the employee quits or is fired before the specified number of years pass, they may lose some or all of their employer’s contribution.
Can after-tax contributions be matched?
Employee contributions are earmarked for retirement and because they are made pre-tax, the IRS imposes strict rules on these contributions. Some companies offer a Roth 401(k) plan in addition to the traditional 401(k) plan. However, contributions to Roth 401(k) plans are made with the after-tax balance. This means that employees can withdraw from their Roth 401(k) tax-free after retiring.
The contribution limit for a Roth 401(k) is the same as for a traditional 401(k). However, unlike a Roth IRA, there’s no income limit for participating in Roth 401(k)s. Any match is considered good primarily because it is free money!
Ubiquity offers customized 401(k) retirement plans for your small business. Reach out today to learn about our affordable, easy-to-manage savings vehicles.