10 Things Employers Should Know About 401k Employer Match Rules

Over the years, employers have come up with many ways to incentivize their staff and keep them motivated. One of the things that we’ve noticed is that employees look for a 401(k) plan when they join a company. In this article, we will go over what a 401(k) matching is and the 10 things every employer needs to know about employer contributions.

Keep reading until the end, as we will also answer some of the most frequently asked questions about 401(k) plans. Let’s get started!

What Is an Employer Match 401(k)?

A 401(k) is a tax-advantaged retirement plan that employers can sponsor on behalf of their employees. In this account, both the employee and the employer make annual contributions. There are different types of plans that we will discuss later on in this article.

Depending on the plan, the employer’s matching contributions may be optional. However, the companies that offer an employer contribution to 401(k) contribute additionally on top of the contributions made by their employees.

401(k) Employer Matches: 10 Things Every Employer Needs to Know About Employer Contributions

In this section, we will go over the 10 things that every employer needs to know about matching contributions and 401(k) employer match rules.

The Average Total Employee and Employer Contribution to 401(k) was 11.3% in 2022

According to a 2023 report titled “How America Saves 2023” by Vanguard, the average match on employee contributions in 2022 was about 4.5% of their yearly compensation, and the average employee contributions for the same year was around 6.8%. In 2022, the total average 401(k) contributions was 11.3%.

When we look at the previous year’s report, the average match on employee contributions was 7% of their annual pay in 2021. After adding the employer contributions, the average 401(k) contribution per employee in 2021 was around 11%.

If we compare the 401(k) employer matching contributions for 2021 and 2022, it tells us that there was a 0.3% increase in 2022. Although this is a minor rise, it shows that both the employees and the employers are saving more money to ensure sufficient retirement savings.

Also Read:  401k Match Pay Period Vs. Annual

A Retirement Plan Is Cheaper Than What Many Employers Think

A 401(k) is a better option for all employers than a life insurance policy, as it is much cheaper. According to a 2022 report published in the ICI Research Perspective, the average management fee for a 401(k) is around 0.57%, much lower than the 3% for a permanent policy.

Besides the high management fees and premiums, a life insurance policy offers a low rate of return. A 2022 study published in the Employee Benefit Research Institute (EBRI) found that the employees’ 401(k)s grew by 15.6% annually, while the fixed interest rate on a permanent life policy stayed between 2% and 3%.

Let’s go over how all of this information would apply to $50,000 in employee savings. The management fees for a 401(k) would amount to $285 annually, while the investment would grow by $7,950 (a 15.6% increase).

On the other hand, permanent life insurance would cost an employer $1,500 annually, and the employee’s savings would only increase by $1,500 (fixed interest rate of 3%).

By choosing 401(k) over insurance policies, we can save more money and recruit and retain talented professionals, which can further help our company grow in the long run.

Retirement Planning Tools

Blizzard Offers the Best 401(k) Company Match

When comparing employer match contributions across multiple companies, it is essential to look at four key metrics, and these include the following:

  • Type: There are two types of employee contributions, and these are as follows:
    • A full match: This is a plan where the employer matches dollar-for-dollar contributions.
    • Partial match: In this plan, the employer contributes a certain percentage of the employee’s contributions.
  • Amount: This refers to the maximum amount an employer may contribute to an employee’s 401k through employer matches. A company can choose either a percentage or a specific dollar amount as the maximum employer contribution.
  • Eligibility: Not all employees may be eligible for employer match contributions. There are a lot of companies that have minimum requirements (years of service) that their employees must meet to qualify for these types of benefits.
  • Vesting period: This refers to the terms pertaining to the availability of the funds. Some companies have a four-year vesting period, while others allow their employees to immediately access the 401(k) employer match contributions.

Ocho, a financial platform that helps businesses manage their finances, conducted research and discovered the 35 companies with the best 401(k) employer match in 2023. We’ve gone through the list, and here are the top three companies:

  • Blizzard
    • Match: 25% of the employee’s compensation
    • Type: Full match
    • Eligibility: Immediately
    • Vesting period: Immediately
  • Dollar General
    • Match: 25% of the employee’s compensation
    • Type: Full match
    • Eligibility: Immediately
    • Vesting period: Immediately
  • Uber
    • Match: 10% of the employee’s compensation
    • Type: Full match
    • Eligibility: Immediately
    • Vesting period: Immediately

A 401(k) Matching Contribution Can Have a Vesting Schedule

When a company offers its employees a retirement savings plan, it may have some terms and conditions on accessing the funds. These rules are often referred to as a vesting schedule. This helps determine whether the funds are immediately accessible to the employee or whether there is a waiting period.

The idea behind a vesting schedule is to keep employees motivated and happy while also protecting the employers. By having a wait limit over the funds, we can retain talented individuals for much longer, reducing the hassles and costs associated with recruitment.

If an employer has a vesting schedule in place and the employee leaves the company before that, they may only receive a small portion of the matched contributions.

There are different approaches an employer may take when it comes to having a vesting schedule. Some may allow their employees to access the funds immediately, while others may have a waiting period, which may vary from one company to another.

In some cases, we may be able to adopt a graduating approach, where a company makes a portion of the funds available to its employees for every year of service they complete. We recommend that all employers should analyze their options before preparing a 401(k) plan for their employees.

Safe Harbor Plan or Profit-sharing Contributions?

According to a 2022 Vanguard report titled “DC plan comparison: Small versus large employers,” 80% of the plans provided an employer contribution in the form of profit sharing and employer matching contributions.

70% of those employee contribution plans used a safe harbor design that not only motivates the employees but is also an incentive for the employer. We will discuss this in more detail later on in this article.

401(k) Employer Match Contributions Calculation

401(K) Employer Match Contributions Calculation

There are two key figures that are important when calculating employee match contributions, and these include the following:

  • A percentage of the employee’s contribution
  • A percentage of the employee’s salary

Depending on the company, an employer might match up to 100% of an employee’s contribution up to a set percentage of the employee’s salary. As we discussed earlier, some companies may offer a full employer match, while others may provide partial matching. In some cases, an employer may set a dollar amount rather than the percentage of an employee’s salary.

However, it is essential to note that the employer’s deduction for contributions to a defined contribution plan cannot be more than 25% of eligible employees’ annual compensation.

Among Vanguard plan holders, the most common types of matching formulas are as follows:

  • Single-tier formula: 70% of the Vanguard plans use the single-tier formula, whereby an employer pays $0.5 per dollar on the first 6% of the employee’s salary.
  • Multi-tier formula: 23% of the Vanguard plans use the multi-tier formula, whereby an employer pays $1 per dollar on the first 3% of the employee’s salary and $0.5 per dollar on the next 2%.
  • Dollar cap: 6% of the Vanguard plans use the dollar cap formula, whereby an employer may use either of the above two formulas with a $2,000 maximum limit on the employer contributions.
  • Other: 6% of the Vanguard plans use a formula based on many different factors, including age and years of service.

Assuming that an employee’s annual salary is $50,000, here’s how we calculate the employer match according to the single-tier and multi-tier formulas mentioned above:

  • Single-tier formula
    • The employee’s annual contribution: $3,000 ($50,000 x 6%)
    • Our annual contribution: $1,500 ($3,000 x 0.5)
    • Total annual contribution to the 401(k): $4,500 ($3,000 + $1,500)
  • Multi-tier formula
    • The employee’s annual contribution: $2,500 ($50,000 x 5%)
    • Our annual contribution: $2,000 ($1,500 + $500)
    • Total annual contribution to the 401(k): $4,000 ($2,500 + $1,500)

According to the calculations above, it’s clear that an employee can increase their 401(k) between 50% and 80% if they set the annual contribution to the ceiling of their employer’s matching contribution.

Important 401(k) Employer Contribution Rules

There are several rules for 401(k) employer match contributions, with most of them pertaining to the contribution limits.

Although we have a degree of control over how much contributions we can make to our employee’s 401(k), the Internal Revenue Service (IRS) is responsible for setting the contribution limits, which we must adhere to.

According to the IRS, the maximum employee contribution limit for 2023 is $23,500, while the catch-up contribution limit for those aged 50 or above is $7,500. These limits are applicable across multiple 401(k) plans.

If one of the employees decides to switch jobs and joins another company, there are certain limits on the total combined contributions they can make to their 401(k) plans. This limit stands at $23,500 or $30,000 (for those who are 50 years old or older).

An employee can also make non-tax-deductible contributions to their 401(k) above the limits mentioned under the IRS guidelines for employer match contributions.

It’s important to be aware that this kind of arrangement is only allowed in 20% of the plans, and the contributions cannot surpass the 2023 limits, which are set at $66,000 or $73,500 (for employees aged 50 or older).

Employers Can Avoid Discrimination with the Safe Harbor Plan

Besides the contribution limits on employer and employee contributions, there are other discretionary contribution rules set by the IRS that we must follow.

The IRS uses nondiscrimination tests to ensure that the retirement plans do not unfairly benefit the company owners and that it is fair and equitable for all employees (the contribution to highly-compensated employees should not exceed the contributions made to other employees).

We understand that dealing with these tests can be both time-consuming and costly for an employer, but there’s a way to avoid all of this hassle – by opting for the safe harbor plan.

Under the safe harbor plan, all eligible employees receive an employer contribution, and at the same time, the employers get to avoid the 401(k) nondiscrimination tests.

A safe harbor plan can take any of the following three forms:

  • Non-elective contributions: Under this plan, a company must contribute 3% or more of the employee’s compensation to the 401(k), regardless of whether the employee makes any contributions.
  • Basic matching: In the basic matching plan, a company must match 100% of all employee contributions up to 3% of their compensation plus another 50% match of the contributions on deferrals between 3% and 5% of their annual salary.
  • Enhanced matching: Under this plan, a company must be as generous as the basic match formula. A general rule of thumb is that the employer must match 100% of the first 4% of each employee’s contribution.

There are certain requirements we must fulfill to be eligible for the safe harbor plan. These include giving all eligible employees the necessary information about their rights and responsibilities under the program, along with the details about the deferral process.

Only a Few Employers Offer Roth Deferrals

A Roth 401(k) deferral is an after-tax contribution, meaning employees can withdraw their funds tax-free upon retirement. Any employer offering matching contributions must also offer the same if they’re providing a Roth 401(k) deferral. We recommend that all employers discuss their options with a 401(k) advisor.

Employer Contributions Are Tax-deductible

Employer Contributions Are Tax-deductible

One of the key benefits of employer contributions is that these are tax-deductible on a company’s federal tax returns each year.

An employer may receive a $500 tax credit for the first three years if they offer their employees a 401(k) for the first time. This can help offset the cost of managing a 401(k) retirement account and even the employer matching contributions.

Final Thoughts

There are many different 401k employer match rules that employers should be aware of to help maximize the benefits to their company. Our advice for all employers reading this is that they should reach out to a 401(k) advisor to discuss their options.

Frequently Asked Questions

How Does a 401(k) Match Work?

A 401(k) match is a plan where an employer contributes to the employee’s retirement savings. An employer may match an employee’s contributions by 25%, 50%, or even up to 100%.

What Is a Catch-up Contribution?

A catch-up contribution is an additional contribution to the 401(k) plan for employees who are 50 years or older.

Can My Employee Borrow from Their 401(k) Plan?

Employees may have the option to take out a loan from their 401(k) – specifically, they can borrow the lesser of 50% of their vested account balance or $50,000. This depends on the type of plan they’re enrolled in.

However, it’s crucial to keep in mind that if an employee decides to leave their job, the situation changes. They might have to repay the loan right away or manage the remaining amount by transferring it to an IRA or another retirement plan.

What Is a Dollar-for-dollar Match Contribution?

A dollar-for-dollar match contribution is when an employer pays the exact amount the employee contributes to their 401(k) plan.