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Updated Oct 20, 2023

How Does 401(k) Matching Work for Employers?

Offering a 401(k) matching program as part of your employee retirement plan can be a helpful incentive for attracting top employees to your business.

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Max Freedman, Business Operations Insider and Senior Analyst
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This guide was reviewed by a Business News Daily editor to ensure it provides comprehensive and accurate information to aid your buying decision.

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Retirement plans are among the benefits employers most commonly offer their employees. Some employers take their retirement offerings a step further by offering 401(k) employer matching, which incentivizes employees to participate in the company’s 401(k) plan by adding money into their retirement savings based on how much they contribute each pay period.

If you’re thinking about opening retirement accounts for your team, want to improve your existing 401(k) options, or are in need of a new 401(k) plan for a startup, you should consider setting up a 401(k) employer match. Before doing so, though, you need a clear understanding of what 401(k) employer matching is, what the benefits are and how you should operate your matching program.

Editor’s note: Looking for the right employee retirement plan for your business? Fill out the below questionnaire to have our vendor partners contact you about your needs.

What is 401(k) employer matching?

401(k) employer matching is the process by which an employer contributes to an employee’s retirement account based on the employee’s contributions. Employers tend to set their 401(k) contribution limits based on the employee’s annual salary. In other words, an employer’s contribution rate may be at most a certain percentage of the employee’s salary. For example, an employer may be willing to match 50% of an employee’s contribution, up to 6% of their annual salary. So, if the employee contributed 6% to their 401(k) plan, the employer would contribute an additional 3% to the employee’s retirement savings.

Rarely, some employers instead set a contribution limit of a predetermined dollar amount that’s unrelated to the employee’s annual salary. In either case, these contributions are typically made per pay period and reflected on the employee’s paycheck.

Key TakeawayKey takeaway
401(k) employer matching is when an employer also contributes to an employee's retirement account based on the amount the employee contributes.

Why should you offer a 401(k) employer match?

Offering a 401(k) employer match as part of your small business 401(k) plan has three primary benefits for your company:

  • Better recruiting: Not all companies offer a 401(k) employer match, so doing so can help your business stand out to top job candidates. Providing better benefits correlates with hiring better employees.
  • Stronger employee morale and retention: Just as offering 401(k) contribution matching can draw better recruits to your business, this benefit can also improve morale among existing team members and increase employee retention at your company.
  • Employer tax benefits: There are tax savings that businesses can take advantage of by offering 401(k) employer matching. Tax laws allow employers to claim their matching contributions as tax deductions.

Learn more about how small businesses benefit from 401(k) plans.

Retirement savings plans are often considered a key part of a great employee benefits package. Whether they are a taxable fringe benefit depends on whether the plan is tax-deferred.

Is offering a 401(k) employer match mandatory?

Although offering a 401(k) employer match for employees’ retirement plans may benefit your business, there are no laws requiring employer matching. However, if you do offer a 401(k) employer match contribution program, you are legally required to conduct nondiscrimination testing to ensure your program equally benefits all of your employees. These IRS-created tests, known as the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests, ensure that your company’s most highly paid employees benefit as much from tax-deferred contributions as your other employees. 

Also, even though it’s not mandatory, the best employee retirement plans typically include matching as part of the retirement fund package. A certified financial advisor can walk employers through the legalities of 401(k) matching and the different components of 401(k) programs. 

Did you know? Some payroll companies also operate 401(k) plans. See our review of ADP for one such example. 

How does 401(k) matching work?

401(k) matching works by depositing an employer contribution amount into an employee’s 401(k) account. For your 401(K) matching program to succeed, you need to address the following questions.

How much should you match 401(k) contributions?

Employers’ 401(k) match amounts vary widely. However, all contribution limits and withdrawal regulations must comply with the standards of the Employee Retirement Income Security Act. Otherwise, you can set your 401(k) contribution rates however you please.

There are two especially common methods for determining how much money you should contribute to your employees’ retirement accounts:

  • As a percentage of an employee’s wages: Some employers will match all employee contributions up to a contribution limit equal to a percentage of an employee’s wages. For example, if you set a contribution limit of 4% of an employee’s income and the employee makes $50,000 per year, you will contribute at most $2,000 (0.04 x $50,000 = $2,000) over the course of the plan year. Note that if your employee contributes less than $2,000 to their retirement account, you have to match only that amount, not the full $2,000.
  • As a percentage of an employee’s contributions: Other employers will match a percentage of contributions instead. For example, if you choose to match 40% of your employees’ contributions with the same 4% contribution limit as in the prior scenario, then for an employee with a $50,000 annual salary, your employer contribution limit isn’t $2,000 over the course of the plan year. Instead, it’s $800 (0.4 x $2,000 = $800).
Did You Know?Did you know
Self-employed 401(k) plans may not offer employer matching, but they still allow independent contractors and sole proprietors to save for their retirement.

What is the maximum amount you can contribute to 401(k) plans?

When determining how much money you should contribute to an employee’s retirement account, you should also consider the annual contribution limits that the IRS sets for both you and your employee. For 2022, the limit on elective salary deferrals – retirement plan contributions an employee voluntarily makes – is $20,500 for a traditional 401(k) plan. For a SIMPLE 401(k) plan, this limit is lowered to $14,000. Employees age 50 and older can contribute an additional $6,500 in elective salary deferrals to a traditional 401(k) plan or $3,000 to a SIMPLE 401(k) plan.

The total contribution limit a person can make to an employer-sponsored retirement account during a year is the sum of elective salary deferrals, employer contributions and allocations of forfeitures. For 2022, the total contribution limit is $61,000; for an employee with an annual income below $61,000, the limit is whatever their income is. Notably, if an employee has a retirement account with your company and a separate 401(k) they contribute to through side income they generate as an independent contractor, that separate account is unaffected by the limits on the employer-sponsored account.

How does 401(k) vesting relate to your 401(k) matching program?

As an employer, you can take ownership of part or all of your employer match contributions through a practice known as vesting. The legal definition of “vesting” is the right to ownership over a future payment, benefit or asset. When applied to retirement accounts, vesting describes the process of employees earning greater rights to access their employer contributions as time passes. That’s why the vesting schedule you set for your 401(k) employer match is a crucial component of your program.

If you’re considering borrowing from your 401(k), keep in mind you can only borrow against the vested amount of your employer match, not the gross total that includes the non-vested matching funds.

Your vesting schedule can incentivize employees to stay with your company longer because the longer your employees stay with you, the more their nonforfeitable rights to your employer contributions grow. After a set number of years, your employee can leave your company while taking all of your employer matching contributions with them, but employees who leave too soon may forfeit some or all of your employer matching contributions.

Alternatively, offering immediate vesting is an appealing benefit for employees too. They’ll have the comfort and security of knowing that should they leave your company for any reason at any time, their 401(k) funds are going with them regardless of how long they’ve been employed with you. This option is likely to make your business more attractive to new hires.

Key TakeawayKey takeaway
To figure out how your 401(k) matching process will work, determine your employer match contribution limits, familiarize yourself with the IRS-mandated 401(k) contribution limits and determine a vesting schedule that drives employee retention while minimizing your financial risk.

401(k) matching makes financial sense

401(k) matching makes financial sense for employers and employees alike. Employee matching is the best way for employees to maximize their retirement savings, while employers get the benefits that come with investing in their team members’ futures – namely, tax savings and reduced employee turnover. Learn more about employee retirement plans and their features in our buyer’s guide.

Kimberlee Leonard contributed to the writing and reporting in this article.

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Max Freedman, Business Operations Insider and Senior Analyst
Max Freedman has spent nearly a decade providing entrepreneurs and business operators with actionable advice they can use to launch and grow their businesses. Max has direct experience helping run a small business, performs hands-on reviews and has real-world experience with the categories he covers, such as accounting software and digital payroll solutions, as well as leading small business lenders and employee retirement providers. Max has written hundreds of articles for Business News Daily on a range of valuable topics, including small business funding, time and attendance, marketing and human resources.
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