The Role of The Company Match in Your 401(k) Plan
Some employers match part or all of their employees’ retirement account contributions.
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Actually, your employer need not be a company at all – it could be a non-profit organization or a governmental entity that contributes to your account. So you can think about a company match as an employer match. Aside from some parts of the federal government’s Thrift Savings Plan, employers are not obligated to contribute to their employees’ retirement accounts. There is no law or tax code that makes the company match mandatory, with the exception of SEP IRA and Simple IRA plans used by some small businesses.
Employers include a company match as part of a benefits package. Like any other benefit, part of the rationale behind the company match is to entice people to want to work for the employer. People are attracted to employers with good benefits packages. Also, employers receive a tax benefit for contributing to employee 401(k) accounts. A company match has the power to greatly increase the value of an employer-sponsored retirement savings account.
There is a wide range of company match levels. A typical matching situation is: the employer matches 50% of employee contributions for the first 6%-of-salary that an employee contributes – so the company will not match more than 3% of the employees’ salary. (See Example A below.) Some companies will provide a straight match, up to a certain limit – rather than matching 50% of employee contributions, they will match 100% of employee contributions up to a set percentage-of-employee-income. (See Example B below.) A few companies will provide a dollar-for-dollar match on all contributions by an employee, though it is rare. Under those circumstances, the company match would be limited only because the employee contribution is limited . Here are some example scenarios to illustrate how company matches work:
Example A – Company Matches Percentage of Employee Contribution, Up to Limit:
- Susie Smith makes $50,000 and has elected to contribute 6% of her annual salary to her 401(k) plan
- Susie’s company will match 50% of her contributions, only up to 3% of her salary
- Each year, Susie would contribute $3,000 (6% of her salary) to her 401(k) plan
- Each year, Susie’s company would contribute $1,500 (3% of her salary) to her 401(k) plan
- The total yearly contribution made to Susie’s retirement account would be $4,500
- Even if Susie elected to contribute 10% of her salary to her 401(k) plan, which would be $5,000, her company still would only contribute 3% because they stipulated that their match is capped at 3% of employee salary
Example B – Company Directly Matches Employee Contribution, Up to Limit:
- George Jones makes $50,000 and has elected to contribute 5% of his annual salary to his 401(k) plan
- George’s company offers a 7% match
- Each year, George would contribute $2,500 (5% of his salary) to his 401(k) plan
- Each year, George’s company would contribute $2,500 (5% of his salary) to his 401(k) plan
- The total yearly contribution made to George’s plan would be $5,000
- George’s company would be willing to match up to 7% of his salary (up to $3,500); since George only elected to contribute 5%, that is all his company will contribute.
Vesting refers to the practice of delaying an employee’s ownership of the company match (or any other company contribution, like profit-sharing) for a specified number of years. So a company match contribution to a 401(k) plan will grow as part of the overall account value, but the employee could not rollover or take distributions on any portion of company match money that is not vested, or owned by that employee. Here is a simplified example of vesting:
- Liz Jones makes $50,000 and has elected to contribute 6% of her annual salary to her 401(k) plan
- Liz’s company offers a 6% match, which is vested after 3 years
- Each year, Liz would contribute $3,000 (6% of her salary) to her 401(k) plan
- Each year, Liz’s company would contribute $3,000 (6% of her salary) to her 401(k) plan
- The total yearly contribution made to Liz’s plan would be $6,000
- Liz has decided to end her employment with this employer and rollover her 401(k) plan to her new employer
- Since Liz has 0% vesting until the 3-year vesting period is over, she could not rollover any of the company match contributions from the past three years; that money simply would be lost to her.
The above example is simplified because it does not reflect the use of a vesting schedule, which most companies use. For example:
- Assume the vesting period for a company is four years.
- One year after employment commences, the employee is 25% vested; the employee owns 25% of company contributions.
- Two years after a employment commences, the employee is 50% vested; the employee owns 50% of company contributions.
- Three years after employment commences, the employee is 75% vested; the employee owns 75% of company contributions.
- Four years after employment commences, the employee is 100% vested; the employee owns 100% of company contributions.
Once the employee has been employed for four years, he/she is 100% vested. The vesting schedule normally begins when employment commences and does not re-start with each employer contribution. As you can see, vesting creates a situation in which the employee cannot own all of the company contributions unless the employee stays at the company for the entire vesting period. There is a great range of vesting limits and schedules. Many companies do not have vesting, a situation that is also known as immediate vesting because employees own company matches as soon as the company makes the contribution.
Because each company can establish retirement plan guidelines please review your Summary Plan Description for specific information about your plan’s vesting.