A 401(k) match is sometimes referred to as “free money.” That is because if you contribute a certain amount to your employer’s 401(k) plan, they will match a certain percentage of the amount you contribute. This is money they contribute to your plan. There is no cost to you other than making your contributions.
What is 401(k) matching?
Many employers offer matching contributions to participants in their 401(k). Matching contributions are deposited into the participant’s account within the plan and are equal to how much the employee added to their retirement savings up to a specified amount.
One of the most common forms of 401(k) matching is when the employer matches a percentage of the employee’s contributions up to a specified percentage of their salary. Other forms of matching might include a match up to a certain dollar amount of employee contributions or an employer matching contribution of a flat percentage for all employees, regardless of how much or whether they contribute to the plan.
How does 401(k) matching work?
There are a few varieties of the 401(k) match.
If your employer says there is a 100% match, this means that they will match 100% of your contributions up to a specified limit. For example, if they match employee contributions up to 4% of their salary, this means that the employer would add a matching contribution of 100% of the amount of the employee contribution up to 4% of their salary.
If an employee earns $80,000 annually and contributes 10% of their salary, the employer would add a match of 4% of their salary to their account. In this case, the amount of the employer match would be $3,200, in addition to the $8,000 of salary deferral contributions made by the employee.
In some cases, the employer match might be a percentage of the employee’s contributions up to a specified limit. A common example is a 50% match up to salary deferral contributions of 6% of the employee’s compensation. Using the same example of an employee with an $80,000 salary, a contribution of 6% by the employee would earn a match of 3% from the employer. In dollar terms, a $4,800 contribution would receive a $2,400 employer match.
Under either matching scenario, if the employee contributed less than the maximum the company is willing to match, the amount of the matching contribution would be adjusted accordingly. In the first example, if the employee’s contribution was 2% of their salary, the employer match would be 2%. In the second example, if the employee’s contribution was 3% of their salary, the employer match would be 1.5% of their salary.
Employee contributions to a Roth 401(k) are eligible for any applicable employer match. Previously, the matching contribution had to be made into a traditional 401(k) account. However, the Secure Act 2.0. did away with that rule, meaning it is now possible for employers to make matching after-tax contributions directly to employees’ Roth 401(k)s.
401(k) contribution limits
There are annual contribution limits on employee deferral contributions and on total contributions to the employee’s account by the employee and the employer combined.
The annual limit on employee deferral contributions for 2023 is $22,500. For employees aged 50 or over at any point during the year, there is an extra $7,500 catch-up contribution limit, bringing their total contribution limit to $30,000 for the year.
The annual limit on combined employee contributions plus employer contributions for 2023 is $66,000 or $73,500 ($66.000 plus the $7,500 catch-up contribution) for those employees who are 50 or over during 2023.
The employer contributions could be a combination of employer matching contributions and other contributions to the employee’s account, such as via a profit sharing contribution. Any matching contributions made by the employer do not count against the annual employee contribution limit.
401(k) vesting schedules
Vesting is an important issue to understand for any 401(k) participant receiving employer contributions, including employer matching contributions. If your plan has a vesting schedule, you will not fully own the employer’s contributions made to your account if you leave the company prior to being fully vested. The IRS allows two maximum vesting schedules for plans.
Three-year cliff vesting
Under this arrangement, the participants are 100% vested in their employer contributions once they have been credited with three full years of service as an employee. Prior to that, they have zero vesting in the employer contributions.
| Years of service | Vesting percentage |
|---|---|
|
Years of service 0 |
Vesting percentage 0% |
|
Years of service 1 |
Vesting percentage 0% |
|
Years of service 2 |
Vesting percentage 0% |
|
Years of service 3 |
Vesting percentage 100% |
The employer could use a more favorable cliff vesting schedule, offering, for example, full vesting after the completion of two years of employment. They could not, however, use a more restrictive vesting schedule, such as, for example, full vesting after four years of employment.
Two to six-year graded vesting
Under a graded vesting schedule, the employer contributions become gradually vested on a graded schedule. If an employee leaves prior to full vesting, they can take with them any portion of the employer contributions that are vested.
| Years of service | Vesting percentage |
|---|---|
|
Years of service 0 |
Vesting percentage 0% |
|
Years of service 1 |
Vesting percentage 0% |
|
Years of service 2 |
Vesting percentage 20% |
|
Years of service 3 |
Vesting percentage 40% |
|
Years of service 4 |
Vesting percentage 60% |
|
Years of service 5 |
Vesting percentage 80% |
|
Years of service 6 |
Vesting percentage 100% |
Again, the employer can have a less restrictive graded vesting schedule, such as full vesting after four years, but not a more restrictive one, such as graded vesting over an eight-year period.
In some cases, employer contributions must be immediately vested. Safe harbor matching contributions are an example. A safe harbor plan allows the employer to be exempt from annual nondiscrimination testing. This testing can be a problem for plans where higher-earning employees make an inordinate percentage of the contributions to the plan.
In exchange for this exemption, the employer makes a match or a contribution to the employee’s account that is immediately vested. Additionally, some employers may offer matching or other contributions that are immediately vested as a feature of their plan, even if it is a non-safe harbor plan.
How to maximize your employer’s 401(k) match
Maximizing your employer’s 401(k) match means contributing the full amount required to receive the maximum matching contribution offered by your employer.
For example, if your employer offers a full match up to 4% of your compensation that you contribute, then you would need to contribute an amount that corresponds to 4% of your compensation to receive their full match.
If your compensation is $60,000, then 4% would be $2,400 in contributions. If you contributed at least that amount, then you would receive $2,400 in matching contributions from your employer. However, if your contributions were, say, only 3%, or $1,800, then the amount of the match would be $1,800. In essence, you would be missing out on $600 in employer matching contributions in this example, or $600 in “free money.”
FAQs
Is a 401(k) worth it with matching?
You will need to evaluate your company’s 401(k) plan to determine if it is worth contributing to. One consideration might be the level of the employer’s matching contributions. This is essentially “free money” that the employer gives to you. It may be worthwhile to contribute at least enough to receive the full employer match even if the plan is a bit subpar.
Do you need to pay taxes for employer 401(k) matching contributions?
Employer 401(k) matches are only taxable at the point of deposit if made to a Roth 401(k). Money paid into a Roth by an employer would be taxable to the employee in the year it is received as these accounts are funded with after-tax dollars. Matching contributions made to a traditional 401(k) account, along with other money in the account, are subject to taxes when withdrawn rather than when deposited.
What is a good 401(k) match?
Obviously, the higher the match, the better. Typical 401(k) matches are:
- A 100% match on the first 3% of employee contributions plus a 50% match on the next 3% of their compensation contributed by the employee.
- A full 100% match on the first 4% to 6% of employee compensation contributed.
- At least 3% of employee contribution regardless of the amount, if any, contributed by the employee. This is a non-elective contribution.
What does 6% 401(k) match mean?
A 6% 401(k) match means that the employer will match up to 6% of the employee’s income if they make a large enough contribution to qualify for the full match. For an employee who earns $60,000, a 6% matching contribution would equate to $3,600. For an employee earning $75,000, the match would not exceed $4,500.