401(k) Matching

401(k) matching is a mechanism by which an employer may contribute a specific amount or percentage to an employee’s retirement savings account as a result of the employee voluntarily making his/her own annual retirement plan contribution. Of course, each employer 401(k) plan differs in the manner in which the employer may offer a matching contribution to supplement an employee’s retirement savings contribution. In the typical scenario, an employer offers the employee a percentage match of the employee’s annual salary. In another scenario, an employer may simply agree to match an employee contributions made to a specific dollar threshold, regardless of the employee’s level of annual compensation.

While Employee Retirement Income Security Act (ERISA) regulations set forth guidance on employees regarding contribution limits and withdrawals, an employer is generally left to initiate and define customized terms of their 401(k) plan with less regulation. An employer may offer a generous matching contribution plan to incentivize existing talent or to attract new talent or may decide not to offer a matching contribution plan at all. Any prospective or newly hired employee should study his/her employer’s 401(k) plan to determine the terms and extent of the employer’s matching contribution plan.

Though most employers contribute to an employee’s 401(k) plan via matching contributions, some employers choose to contribute additional periodic monetary deferrals to their employee’s retirement accounts regardless of 401(k) plan employee contributions. In the more common scenario, an employer will offer a matching contribution to a maximum of 100 percent of the employee’s contributions up to a maximum percentage of the employee’s total annual compensation or the employer agrees to match a specific percentage of employee contributions. If the employer elects to match a percentage of the employee’s contributions, an employee will likely need to contribute more to their 401(k) plan to maximize their employer match. Along these lines, employers may decide to only provide matching contributions of a defined amount, despite the employee’s income amount, which provides the employer with the ability to limit contribution those employees that are compensated at a higher level.

Let’s try to explain these concepts through an example. An employee earns $70,000 in annual compensation. His employer has a policy that dictates that the employer will only contribute to your 401(k) plan to a maximum of $2,800. As such, the employee must contribute $2,800 (4 percent of your annual compensation) to their 401(k) plan to avail themselves of the full employer match. If the employee were to contribute 5 percent of their annual compensation to your 401(k) plan, the percentage amount above 4 percent would not be matched by their employer. Thus, if an employee contributed $6,000 this year and the employer provide their stated matching amount, the employee and employer contributed amount would be $8,800.

However, let’s say that the same employee still earns $70,000 per year and the employer’s retirement plan dictates that an employee may contribute 6 percent of their salary ($4,200) and remain eligible for an employer matching contribution. However, in this case, the employer will only match 50 percent of retirement plan contributions, which means your employer will still only provide a matching contribution of $2,100. No different than the first scenario. But, as you can see, under this scenario, the employee must contribute twice the amount ($4,200 versus $2,100) in his/her 401(k) account to get the same match the employee offered in the first scenario.

The IRS establishes annual contribution limits on contributions both from the employee and from any form of employer matching. In 2017, the IRS has set forth guidelines that stipulate that the total contributions to 401(k) accounts made by employees/employers must remain under the threshold of $54,000 or the amount equal to 100 percent of the employee’s compensation, whichever amount is lower. Additionally, employee salary elections are limited to $18,000 per annum. However, the IRS does allow those getting closer to retirement (over the age of 50) to make an additional contribution of $6,000 per year to allow them to catch-up in terms of retirement saving.

Vesting

When an employer makes a matching contribution to an employee 401(k) account, the employer will likely dictate the employee’s degree of ownership in these matching contributions by instituting a vesting schedule that will largely correlate with the employee’s length of employment. Thus, if an employee terminates his/her employment, whether voluntarily or involuntarily, before reaching the employer’s stated vesting period, the employee will likely forfeit some of the employer’s matching contributions. During the vesting period, the matching contributions made by an employer to the employee’s 401(k) will continue to grow in the employee’s 401(k) account, but should an employee terminate his/her employment, these matching contributions will not be rolled over to another plan.

In the typical vesting schedule, an employer will institute a graduated scale of ownership that increases with an employee’s length of employment. The Bureau of Labor has indicated that the average number of years to elapse before an employee is fully vested in its employer’s contributions is now five years. It should be noted that any contributions made by employees to their 401(k) accounts are 100 percent vested once made and will never be forfeited.

The Role of the Company in Matching the 401(k)

Presently, many employers choose to match a portion or all of its employee’s retirement plan contributions. Generally, employers are not legally obligated (through law or tax code) to offer a matching contribution program to their employee’s retirement plan accounts. The only exceptions are for SEP IRA and Simple IRA plans that are implement for employees of small businesses.

Most employers offer matching contributions to their employee’s 401(k) retirement plans as a significant portion of any employee benefits package. Also, employers are incentivized to offer such contribution plans as they stand to receive a tax benefit for such contribution to employee 401(k) accounts. Additionally, matching contributions provide a mechanism by which the value of the retirement savings accounts can greatly increase.

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