Beyond being an attractive employee benefit, a 401(k) plan can act as a catalyst for employees at all career stages to save for retirement. Some employees, however, will resist saving because they feel retirement is too far away, or can’t afford it, or can’t grasp the benefit to making room in their budget (and current spending levels). However, as a 401(k) plan sponsor, you can help change that mentality by offering a 401(k) employer matching contribution.
What is a 401(k) employer matching contribution?
With an employer match, a portion or all of an employee’s 401(k) plan contribution will be “matched” by the employer. Common matching formulas include:
Carla works for ABC Company, which runs payroll on a semi-monthly basis (two times a month = 24 pay periods a year). Her gross pay every period is $2,000. She has decided to defer 4% of her pre-tax pay every pay period, or $80 (4% x $2,000). The ABC Company 401(k) plan generously offers a dollar-for-dollar match up to 4% of compensation deferred. With each payroll, $80 of Carla’s pay goes to her 401(k) account on a pre-tax basis, and ABC Company also makes an $80 matching contribution to Carla’s 401(k) account.
At a 4% contribution rate, Carla is maximizing the employer contribution amount. If she reduces her contribution to 3%, her company matching contribution would also drop to 3%; but if she increases her contribution to 6%, the formula dictates that her employer would only contribute 4%.
Partial Match (simple):
Let’s take the same scenario as above, but ABC Company 401(k) plan matches 50% on the first 6% of compensation deferred. This means that it will match half of the 401(k) contributions. If Carla contributes $80 to the 401(k) plan, ABC Company will contribute $40 on top of her contribution as the match.
By applying different percentages to multiple tiers, employers can encourage employees to contribute to the plan while controlling their costs. For example, ABC Company could match 100% of deferrals up to 3% of compensation and 50% on the next 3% of deferrals. Carla contributes 4% of her pay of $2,000, which is $80 per pay period. Based on their formula, ABC Company will match her dollar-for-dollar on 3% of her contribution ($60 = 3% x $2,000), and 50 cents on the dollar on the last 1% of her contribution for a total matching contribution of $70 or 3.5%.
The plan’s matching formula is chosen by the company and specified in the plan document or may be defined as discretionary, in which case the employer may determine not only whether or not to make a matching contribution in any given year, but also what formula to use.
Is there a limit to how much an employer can match?
The IRS limits annual 401(k) contributions, and these limits change from year to year. For 2020, employee contributions are limited to $19,500 (or $26,000 if you’re 50 or over). While employer contributions do not count towards these employee contribution limits, there is a limit for employee and employer contributions combined to the lesser of 100% of an employee’s gross compensation or $57,000 ($63,000 if you are 50 or over). It’s also important to note that the IRS caps annual compensation that’s eligible to be matched.
Potential Benefits of Providing an Employer Match
- Attract talent: Offering a 401(k) is a great way to set your company apart from the competition, and a matching contribution sweetens the deal! A recent Betterment for Business study found that more than 45 percent of respondents considered a 401(k) match to be a factor when deciding whether to accept a job.
- Better 401(k) plan participation: Unlike other types of employer contributions, a matching contribution requires employees to contribute their own money to the plan. In other words, the existence of the match drives plan participation up (not contributing is like leaving money on the table), encouraging employee engagement and increasing the likelihood of having your plan pass certain compliance tests.
- Financial well-being of employees: A matching contribution shows employees that you care about their financial well-being and are willing to make an investment in their future. The additional funds can help employees reach their retirement savings goal.
- Reduced hidden costs: When evaluating the cost of an employer match, it is important to weigh long-term, less immediate benefits for the company. Without a matching contribution, employees may have to work longer than they otherwise would, which can lead to higher costs in the form of higher healthcare expenses, lower productivity and increased absenteeism, not to mention fewer promotional opportunities for other employees.
- Improved retention: The match is essentially “free money” that can be considered part of an employee’s compensation, which can be hard to give up. And by applying a vesting schedule to the employer match, you can incentivize employees to stay longer with your company to gain the full benefits of the 401(k) plan.
- Employer tax deduction: matching contributions are tax deductible, which means you can deduct them from your company’s income so long as they don’t exceed IRS limits. In addition to the combined employee and employer contribution limits mentioned above, there is an additional employer contribution limit which in 2020 was 25% of an employee’s compensation (eligible compensation is limited to $285,000 per participant).
Offering a 401(k) plan is already a huge step forward in helping your employees save for their retirement. Providing a 401(k) matching contribution enhances that benefit for both your employees and your organization.
Ready for a better 401(k) solution?
Whether you’re considering a matching contribution or not, Betterment for Business is here to help. We offer a digital platform that makes it easy for you to set up and maintain a plan, with low cost administration, guided onboarding, and expert investment and administrative support.
Any links provided to other websites are offered as a matter of convenience and are not intended to imply that Betterment or its authors endorse, sponsor, promote, and/or are affiliated with the owners of or participants in those sites, or endorses any information contained on those sites, unless expressly stated otherwise.
Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a qualified tax professional.