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Matching Contribution What it is How it Works FAQs

Matching Contribution What it is How it Works FAQs

Matching Contribution: What it is, How it Works, FAQs

What Is a Matching Contribution?

A matching contribution is a type of contribution that an employer makes to employees’ employer-sponsored retirement plans. It is an amount of money that the employer chooses to make to participating employees’ retirement plans. This amount is usually a percentage of the employee’s contribution.

Key Takeaways

  • A matching contribution is an amount of money that an employer makes to employees’ retirement plans.
  • Matching contributions are based on elective-deferral contributions.
  • An employer might match a certain amount of an employee’s contributions.
  • Vesting may take years to begin.
  • New laws extend the ability to other accounts for employees to take advantage of matching contributions.

How Matching Contributions Work

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.

Vesting periods typically occur before the benefit begins. When an employee is vested, they legally own the money contributed by their employer to their retirement accounts. If an employee leaves the company, they will lose the right to claim any non-vested matching contribution funds.

Vesting also plays a role in employee retention. For instance, stock bonuses can encourage valued employees to remain with the company if there are prospects of acquisition or going public.

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In some cases, vesting is immediate. For example, employees are 100% vested in Simplified Employee Pension (SEP) and Savings Incentive Match Plan for Employees (SIMPLE) contributions. 401(k) plans may adopt a cliff or graded vesting schedule.

Special Considerations

Earnings in a 401(k) plan accrue on a tax-deferred basis. This means that employees do not have to pay taxes on these funds within a given year. When funds are withdrawn at the eligible retirement age of 59½, ordinary income tax is paid if the initial contribution is pretax. Withdrawing funds before age 59½ for a non-qualified reason may incur a 10% penalty.

Compounding makes funds more valuable over time. However, the IRS requires people to begin withdrawing money at a certain point to keep enough funds circulating in the U.S. economy. These withdrawals are called required minimum distributions (RMDs).

If the plan allows it, employees who are still employed after reaching age 72 can delay the RMD until April 1 following the year they retire.

Matching Contributions and Retirement Savings

Individuals have options when saving for retirement, including contributing to their own individual retirement account (IRA) or Roth IRA, in addition to a company’s 401(k) plan. SEP and SIMPLE plans may be more effective for smaller companies.

401(k) plans are the most common form of matching contributions. These qualified employer-sponsored retirement plans allow employees to contribute 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 a profit-sharing feature.

The SECURE Act 2.0 expanded provisions for certain retirement accounts. This includes employer matching contributions to a Roth 401(k) and matching contributions for employees who use their wages to pay off student loans.

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What Percentage of Your Contributions Will Your Employer Match?

The matching percentage depends on the employer. Some employers offer 100% matching contributions, while others do not match anything. A 50% match is common.

How Much Should an Employee Contribute to their 401(k)?

Employees are generally advised to contribute enough to receive the maximum matching contribution from their employer. The more the employer contributes, the better, as it is essentially free money on top of their 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. For example, if an employee earns $60,000 a year and contributes at least 6% of their paycheck to their plan, their company will add an additional $1,800.

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