Retirement Accounts

How 401(k) Matching Works

How 401(k) Matching Works

Salaried employment comes with a few perks. With some employers, one of those perks is a 401(k) match, which has your company putting money into an investment account for you.

Stephanie Faris

Published January 7th, 2021

Table of Contents

Key Takeaways

  • If your employer offers a 401(k), it’s important to look closely at the account terms.
  • Some employers will match the money you put into a 401(k) up to a predetermined limit, which is essentially free money to you, the employee.
  • Employer matching contributions are strictly regulated, so the limits are often inflexible.

Salaried employment comes with a few perks. With some employers, one of those perks is a 401(k) match, which has your company putting money into an investment account for you. Your employer will match the amount you deposit, so you’ll need to make a commitment, as well.

Participating in a 401(k) employer match can be a great way to set money aside for the future even if you’re on a tight budget. Since your employer’s contribution is free money, your company’s 401(k) should be the first step you take toward saving for retirement. Here’s what you need to know about how 401(k) matching works.

How 401(k) Matching Works

A 401(k) company match is a popular business perk. For businesses, it serves as a great way to attract top talent. After you’ve evaluated salary, health insurance, and time off, a method to easily prepare for your future is a huge perk.

To understand how a 401(k) match works, it can help to first understand how 401(k) contributions work. Your employer will typically take out a percentage of each paycheck to put toward your 401(k). You’ll be allowed to choose how much you contribute, but there will be a limit.

For example, if your employer matches, there will be a limit to how much that match will be, as well. You may choose to have 5 percent of your weekly pay taken out, which would be $250 of a $5,000 monthly salary. But your employer may only match 4 percent or $200 of that amount, which would mean you’d have $450 per month going toward your 401(k).

401(k) Matching Varies by Employer

But any answer to what is 401(k) matching needs to stipulate that it depends on the employer. Some employers offer a dollar-for-dollar match while others set a fixed percentage of your paycheck. Your own participation requirements can vary, as well.

If you’re considering taking a position with a matching 401(k) contribution, the best thing you can do is iron out those details before accepting the position. Some employers may be willing to negotiate the match, which could make up for a position with a lower salary or less attractive health plan than other employers are offering.

Employer Matching Contribution Formulas

To understand how does employer 401(k) match work, it’s important to take a look at the restraints employers operate under. Any employer offering a 401(k) match must follow IRS regulations regarding contributions.

With the most popular type of 401(k), a safe harbor plan, employers must choose from one of three formulas:

  • Basic match – Employer matches 100 percent on the first 3 percent of the compensation plan plus a bonus match of 3 to 5 percent on deferrals to total 4 percent.
  • Enhanced match – Employer matches at least as much as it would with a basic match with a cap of 6 percent total of compensation.
  • QACA match – Short for Qualified Automatic Contribution Arrangement, this match combines 100 percent of the first 1 percent of compensation with a 50 percent match on deferrals between 1 and 6 percent to total 3.5 percent.

Employers don’t have to go with a safe harbor plan, though. Part of the 401(k) match meaning is flexibility. If your employer opts for a non-safe harbor match, it will need to pass both the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests. Matches will still need to fall below a certain threshold, but the limits are higher.

Contribution Limits

In addition to matching limits, both employees and employers are bound by IRS-geared 401(k) contribution limits. For 2021, employees can contribute up to $19,500 to a 401(k) plan. If you’re over the age of 49, you can make an additional catch-up contribution of $6,500.

Any employer contribution to 401(k) plans is subject to regulatory limits, as well. That limit is much higher, $58,000 in 2021. For employees ages 50 and up, employers can add a $6,500 catch-up contribution to that limit.

401(k) Vesting Schedules

When you’re looking at how 401(k) matching works, it’s important to note that you won’t just start enjoying your benefits the day you begin employment. Most retirement plans are subject to something called vesting, which means you officially own your retirement account. If your employment terminates before reaching that threshold, you won’t be eligible to receive its benefits when you retire.

Vesting typically works on a schedule. You might earn 20 percent after two years of service, 30 years at three, and so on. Once you reach the 100 percent threshold, no matter what happens with your employment, those funds will be available to you at retirement. If your employment terminates at only two years, in the above scenario, you’d only be entitled to receive 20 percent of the matched funds in the account at retirement.

So what does 401(k) match mean in light of this? If you leave before being fully vested, any money your employer has put into the plan will go back into something called a forfeiture account. Those funds can be used to cover plan administration costs or be put toward other participants in the plan. It is important to note any funds that you've contributed will remain yours and are not subject to any forfeiture.

Final Thoughts

Although it may seem complicated, 401(k) matching explained is really quite simple. If you can afford to do so, make sure you’re contributing the minimum amount necessary to qualify for your employer’s full match. Once you’ve done that, you can decide what the best option is for your retirement savings. We recommend working with a Certified Financial Planner® as early as possible to ensure you’re making the most of your available options.

Retirement Accounts

Understanding 401(k)s

401(k) Rules

Cashing Out your 401(k)

Understanding Roth 401(k)s

Roth IRA Basics

Free Retirement Consultation

Still have questions about how to properly plan for retirement? Speak with a licensed fiduciary for free.


Stephanie Faris

Stephanie Faris has written about finance for entrepreneurs and marketing firms since 2013. She spent nearly a year as a writer for a credit card processing service and has written about finance for numerous marketing firms and entrepreneurs. Her work has appeared on Money Under 30, The Motley Fool, MoneyGeek, E-commerce Insiders, and GoBankingRates.

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