A Match Made in 401(k) Heaven – Almost

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The rules for employer matching of an employee’s 401(k) contributions will be outlined in the terms of the 401(k) plan, and these rules can vary widely from one plan to another. It is therefore important to check your plan before you make any financial decisions.

Naturally, the employer matching must also adhere to applicable law, including the Employee Retirement Income Security Act (ERISA). Also, all deferrals to a 401(k) are subjected to an annual contribution limited set by the Internal Revenue Service (IRS). This is true regardless of whether the money comes from the employee or from the employer. For individuals aged 50 or over, the IRS allows for special catching-up contributions that are governed by a separate set of rules.

Employer matching of employee contributions

Employer matching can be a great way for you, the employee, to grow your 401(k) since you can make contributions to the plan and see them matched by a contribution from your employer. Typically, an employer will match a percentage of your contribution – up to certain portion of your total salary. There are also plans where the ceiling is set in a dollar amount and not as a portion of your total salary.

Please note that not all employer contributions to an employee’s 401(k) are the result of matching. An employer can for instance make regular contributions to the employee’s 401(k) regardless of employee contributions.

Example #1

Your employer offers a 100% match on employee contributions, up to a maximum of 3% of annual employee income. If your annual income is $50,000 that means that the ceiling for employer matching is $1,500. If you for instance contribute $1,800 to your 401 (k) you still only get a $1,500 matching from your employer that year.

Example #2

Your employer offers a 50% match on employee contributions, up to a maximum of 3% of annual employee income. If your annual income is $50,000 that means that the ceiling for employer matching is $1,500. However, since your employer only give a 50% match, you must contribute $3,000 to get a $1,500 contribution from your employer. If you for instance contribute $1,800 to your 401 (k), you only get a $900 matching from your employer that year.

This is called a partial matching scheme with an upper limit, and it is a very common scheme for 401(k) employer matching.

Example #3

Your employer offers a 100% match on employee contributions, up to a maximum of $1 500. It doesn’t matter if your annual income is $50,000 or $500,000 – the employer will not provide more than a $1 500 annual matching regardless of your income. If you for instance contribute $1,800 to your 401 (k), you get a $1,500 matching from your employer.

Vesting schedule

Before you start making any contributions to your 401(k) it is very important that you inform yourself about the plan’s vesting schedule. You need to know what will happen to the money if your employment is voluntarily or involuntarily terminated. With some vesting schemes, the employee will forteit some or all of employer contributions if employment is terminated before a certain number of years have elapsed.

Hurdles

  • Many companies allow for immediate enrollment in a 401(k) when you commence employment with them, but be cautious because quite a few of those companies will place you – the new employee – in a sort of quaranteen and not make any matches until a certain period of time has elapsed.
  • Some companies will not start matching your contributions until a certin amount of your pre-tax income is committed to the plan. Requiring a six or seven percent commitment is not that unusual.

Stock matching

Some companies have an employer matching plan in place, but will not match your contributions with money. Instead, they will give you stocks in the company.

Tiered systems

With a tiered system, employer matching will vary along a set of steps.

Example: For each contribution you make up to and including 3% of your annual income, the contribution is matched by 100%. For contributions above 3% but below 6%, each contribution is only matched by 50%. From 6% of your annual income, no matches are made.

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