What Is a Matching Contribution?
A matching contribution is a type of contribution an employer chooses to make to their employees' employer-sponsored retirement plan. The contribution is based on elective deferral contributions that the employee makes.
- Matching contributions are based on elective deferral contributions.
- An employer might match a certain amount of an employee's contributions.
- It can take years for a vesting period to begin.
How a Matching Contribution Works
Generally, the employer's contribution may match the employee's elective deferral contribution up to a certain dollar amount or percentage of compensation. For example, an employer might match 50% of an employee’s contribution.
It often takes several years or a vesting period for this benefit to begin. When an employee is vested, then they legally own the money their employer has contributed to their 401(k) or other retirement accounts. If an employee leaves the company, they will lose the right to claim any matching contribution funds in which they are not yet fully vested.
Vesting also has strong ties to employee retention. Stock bonuses, for example, can entice valued employees to remain with the company for several years, particularly if the company is promising and might be acquired or go public in the coming year(s), which would mean the employee’s stock would multiply in value.
In some cases, vesting is immediate. For example, employees are 100% vested in SEP and SIMPLEemployer contributions. With regards to a 401(k), a cliff vesting or graded vesting schedule may escalate toward a full matched contribution. Employers should make the vesting schedule available to employees along with information about the 401(k) plan.
Matching Contribution and Retirement Savings
With or without an employer’s matched contributions, individuals have several options when saving for retirement. They can contribute to their own individual retirement account (IRA) or Roth IRA, along with a company’s 401(k) plan. For smaller companies, SEP and SIMPLE plans could be more effective.
The most common form of a matched contribution occurs in a 401(k) plan, however. Notably, 401(k)s are qualified employer-sponsored retirement plans that employees contribute to on a post-tax and/or pretax basis. Employers may make matching or non-elective contributions to the plan on behalf of eligible employees and may add an additional profit-sharing feature.
Earnings in a 401(k) plan accrue on a tax-deferred basis. This means that within a given year, an employee will not have to pay taxes on these funds; however, when they withdraw the amount at 59½, the eligible retirement age, they pay ordinary income tax if the initial contribution is pre-tax. If the employee withdraws funds prior to 59½ for a non-qualified reason, they could incur a 10% penalty.
Individuals must also take required minimum distributions (RMDs) before they reach a certain age, generally 72. Because of compounding, the longer these funds stay in retirement accounts, the more valuable they become. However, the Internal Revenue Service (IRS) forces people to start withdrawing money at a certain point as the U.S. economy needs to keep enough of these funds in circulation.
If the plan allows—and the employee is still employed after they reach age 72—the RMD can be delayed until April 1 following the year the employee retires.
Secure Act 2.0
A new law is in the process of being approved by the government that looks set to revolutionize retirement savings and matching contributions.
On March 29, 2022, the U.S. House of Representatives approved the Securing a Strong Retirement Act of 2022, also known as Secure Act 2.0. This bill, which now heads to the Senate, aims to incentivize Americans to save more for retirement and is widely expected to soon pass in some form and become law.
Notable provisions in the legislation passed by the U.S. House of Representatives include mandatory automatic enrollment, a later starting age for RMDs, increased catch-up contributions, and the following changes for matching contributions:
- Employer matching contributions to a Roth 401(k): At present, employer matching contributions are paid into an employee’s pre-tax 401(k) account. That would change under the second Secure Act, which wants to give employees the option to receive all or some employer matching contributions in their after-tax funded Roth 401(k).
- Student loan matching: Employees using their wages to pay off student loans rather than save for retirement can get matching contributions on these payments, boosting their retirement fund without contributing to it.
What Percentage of Your Contributions Will Your Employer Match?
That depends on how generous your boss is. Some employers offer 100% matching contributions, which is fantastic, while others don’t match anything and contribute zero. A 50% match is common.
How Much Should an Employee Contribute to Their 401(k)?
It’s generally advisable to contribute enough to get the maximum matching contribution from your employer. The more the employer contributes, the better, as this is effectively free money on top of your salary.
How Much Do Companies Typically Match on 401(k)s?
A common employer match on a 401(k) is 50% of the employee’s contribution on up to 6% of their salary. In other words, if you earn $60,000 a year and contribute at least 6% of your paycheck to your plan, your company will add an additional $1,800—6% of $60,000 = $3,600 / 2 = $1,800.