What Is a 401(k) Employer Match?
An Employer Match Can Make Your 401(k) Even More Attractive
What Is a 401(k) Match?
I keep hearing that I should be taking advantage of an employer match in my 401(k). How does that work?
Yes, if your employer matches any portion of your contributions, in most cases it makes sense from a financial perspective to take full advantage of it. To ignore it is to miss out on money you are being offered as part of your benefits package. In fact, not all companies offer a matching program. If yours does, consider yourself fortunate and make the most of it. Here's what you need to know about matching contributions in a 401(k) plan.
How Much Does Your Employer Match
The first thing you need to know is how much of your contribution your employer is willing to match. This is usually expressed as a percentage. There is no standard 401(k) contribution amount that employers use since companies can decide how much to add to an employee's plan. One common employer matching contribution within 401(k) plans is a dollar-for-dollar employer match up to the first 6% of salary. That means for every dollar you contribute up to 6% of your salary, your employer contributes something to match that contribution.
However, it is not necessarily a dollar-for-dollar match. Many employers match each dollar you contribute with $0.50. That means that if you contribute 6% of salary or more, you get an extra 3% from your employer. Those lucky souls who get a dollar match for every dollar they contribute are should count their blessings (and their money).
Vesting: The Rate of Your Employer Match
Vesting is where employer matching gets a little tricky. Vesting is the access that you have to your full match over time. If you are fully vested, your employer matching funds are all yours. If you leave the company, you can take the money with you. Many employers have a graded vesting schedule, which gives employees increased access to matching funds the longer they serve the company.
With a typical vesting schedule, you may not be able to participate in the 401(k) until your second year as an employee. Your vesting may then increase by 25 percent each year until you are fully vested after 5 years as an employee. This is one way employers can encourage loyalty in a competitive job market. If you are 50 percent vested when you leave a company, that means you leave with only 50 percent of your employer's intended match. It is important to know the impact of your vesting schedule in order to fully understand how it affects how much of the employer match you will actually see if you leave your job.
Employees earning high incomes may have different concerns about employee matches. Be careful to spread out your contributions throughout the year. If you reach the maximum contribution limit early in the year, you will miss out on employer contributions for the rest of the year. You can ask your plan administrator for help to ensure that you maximize your employer match.
Why an Employer Match Is Free Money: An Example
One way to appreciate your employer's 401(k) match is to think of it as real money. Say you make $100,000 a year. You contribute 6 percent of your salary on a pre-tax basis, or $9,000. If your employer matches 3 percent, that's $3,000 a year they are adding to your retirement fund. No matter how much you currently earn, a 3 percent match is essentially a 3 percent raise that you are setting aside for later.
Another great reason to take advantage of the 401(k) match is that it allows you to exceed the annual maximum contribution limits. In 2017 you can contribute up to $18,000 in a 401(k), unless you are age 50 or older and can save up to $24,000 with catch-up contributions. With an employer match, you can increase those limits by 3 percent to 6 percent because matching employer contribution limits do not count toward the maximum limits that you can contribute to a 401(k) plan. If you are a highly compensated employee, you can save some serious money for retirement.
So if you are wondering how much to save in your 401(k), start by saving up to the full amount that your employer will match. Anything less is like saying no to that raise you have been waiting for.
Updated by Scott Spann
The content on this site is provided for information and discussion purposes only, and should not be the sole basis for your investment or tax planning decisions. Under no circumstances does this information represent a recommendation to buy or sell securities.