Despite recent increases to retirement savings contributions, most American households do not have sufficient retirement savings. According to the National Institute on Retirement Security, when looking at 401(k) and IRA account balances, 92% of working households fall short of retirement savings targets for their age and income.
For retirement income, 401(k) accounts are the most common savings options that retirees rely on. One of the biggest benefits of a 401(k) plan is that your employer can contribute to your retirement savings via a company match plan. Understanding what a 401(k) company match is and how it works can help you take advantage of employer contributions and maximize your retirement savings.
How Does 401(k) Company Match Work?
A 401(k) is a defined contribution plan. It’s an employer-sponsored retirement savings plan that allows you to save and invest some of your pretax salary for retirement. You can invest your 401(k) savings and continue growing them tax-free until retirement. Unlike a pension plan, a defined contribution plan doesn’t guarantee payment in retirement. When you retire, your benefits reflect your investment’s gains or losses and you’ll pay income tax on them up on withdrawal.
While the idea of tax-deferred growth is appealing, there are contribution and withdrawal limits to a 401(k) that you should keep in mind.
- In 2020, individual 401(k) contribution limits rose to $19,500 per year ($26,000 if you’re over 50) and joint employee-employer contributions rose to $57,000 per year.
- According to the IRS, employer-sponsored retirement plans such as SIMPLE IRAs and 401(k)s are cumulative. In 2020, you cannot contribute more than $19,500 between the 2.
- If you withdraw your 401(k) funds before age 59 ½ you will pay a penalty and you have to make scheduled withdrawals starting at age 70 ½.
There are 3 types of 401(k) plans
1. Nonelective Plans
If your employer opts for a nonelective contribution plan, they put a percentage into your 401(k) regardless of if you contribute. Nonelective 401(k) funds come directly from the company and do not affect your salary. Nonelective plans incentivize employees to start contributing to their retirement accounts as well as invest employees in the company.
2. Profit-Sharing Plan
If your employer offers a profit-sharing plan, they put set amounts into your 401(k) amount based on overall profits. Under this plan, contribution amounts are typically determined in proportion to your pay. Profit-sharing plans are discretionary — employers decide year to year whether they will contribute and how much they will contribute.
3. Company Match Plan
Depending on your company’s 401(k) plan, your employer can either match your contributions up to a certain portion of your salary or contribute partially to your account. While the money you put into a 401(k) is yours even if you terminate employment, many employers have a vesting schedule for contributions. This means that employees must work at the company for a certain length of time to own a percentage of their 401(k) contributions. No matter what, a 401(k) employer match means that your employer is contributing free money toward your retirement savings.
Example of 401(k) Employer Match
The percentage of 401(k) contributions that your employer matches varies widely. Typically, employers contribute a partial match up to a certain portion of your salary (5%–6% is common). If your employer has a partial-contribution plan, then you will have to contribute more from your pretax paycheck to maximize your employer’s matching benefits.
Below is a table with a few examples of 401(k) employer match contributions based on a $50,000 annual salary with up to a 5% salary match.
| 401(k) Employer Match with a $50,000 salary | Employer 401(k) Match Plan | Employee Contribution | Employer Contribution | Total Contribution Needed to Meet Employer Match Maximum | Additional Employee Contributions to Meet Employer Match Maximum |
|---|---|---|---|---|---|
| 100% | 5% of salary ($2,500) | $2,500 | $2,500 | $2,500 | $0 |
| 50% | 5% of salary ($2,500) | $2,500 | $1,250 | $5,000 | $2,500 |
Employer-Match Contribution Limits
A 401(k) employer match does not count toward your maximum individual contribution limits but does factor into your total annual contribution limits. In 2020, 401(k) contribution limits increased, allowing you to put more of your pretax salary toward retirement.
| 401(k) Annual Contribution Limits 2020 | |
|---|---|
| Maximum employee | $19,500 |
| Maximum employee + employer | $57,000 |
| Catch-up contribution limit (age 50+) | $6,500 |
| Maximum employee + catch-up contribution (age 50+) | $26,000 |
| Maximum employee + employer + catch-up contribution (age 50+) | $63,500 |
How to Take Full Advantage of Employer 401(k) Matching
Taking advantage of your employer’s matching contributions is a great way to boost your retirement savings. After all, 401(k) employer match plans guarantee free money toward your retirement savings. Furthermore, your employee contributions are tax-deferred, meaning your contributions grow tax-free and you won’t pay taxes on them until you retire.
If it’s financially possible, you should max out your employer’s contribution limit, even if it means contributing additional funds on your end.
In addition to getting the most of your employer’s matching contributions, you can also maximize your individual contribution limits. While your net income will go down slightly due to your increased contributions, you will benefit from lower income taxes and greater savings.
When deciding how much to contribute to your 401(k) account, don’t forget to consider:
- What percentage of your pay your employer will match
- How much of your contributions your employer will match
While 401(k) match plans are a great tool to help you prepare for retirement, don’t put away more money than you can afford. You still want to be able to have enough money for expenses like your mortgage and property taxes while maintaining an emergency fund that doesn’t have limits age or early withdrawal limits like a 401(k).
Finding Your Ideal Match
If you need help figuring out how much to contribute to your 401(k) or are wondering how to take advantage of your employer’s matching contributions plan, talk to a financial advisor. An advisor can assist you with balancing your retirement savings with your current expenses. They also can help you strategize how to maximize employer matching contributions so that you are getting the most free money possible for your retirement savings.