A 401(k) is a type of qualified retirement plan offered by many employers that allows an employee to deposit pre-tax dollars from each paycheck into a retirement account. An employer can match an employee's contributions in a number of different ways:
- Microsoft contributes $0.50 for every $1 contributed, up to IRS contribution limits.
- Apple matches 50% and 100% of an employee's contribution depending on the length of service of that employee. Employer contributions are limited to 6% of the employee's eligible earnings, up to IRS contribution limits.
- Amazon matches 50% of employee contributions up to 4% of the employee's eligible earnings, up to IRS contribution limits.
- Netflix matches 100% of employee contributions up to 4% of the employee's eligible earnings, up to IRS contribution limits.
In addition to varying contributions, different companies often have different vesting schedules. Some companies allow employees to retain full ownership of employer contributions the day they are hired, while other companies require an employee be on staff for a specific period of time before retaining ownership of contributions. Should the employee leave the company, the employee will own their contributions but not be entitled to the company's match for any vesting period they did not achieve.
When the employee leaves the company, they can choose to rollover the 401(k) into a different plan or withdraw all funds (and be subject to penalties and taxes). If the employee retires and maintained the retirement account, the contributions and investment growth can be withdrawn to provide income or supplement Social Security benefits.
Key Takeaways
- Choosing a 401(k) over a traditional pension puts the onus of contributing and investing for the future on the employee, not the employer.
- If your employer matches your 401(k) contributions make sure to take advantage of the benefit.
- The IRS doesn’t require employers to match employee contributions, though many do.
- Having a retirement plan helps attract and keep talented employees.
- Employers receive tax benefits for contributing to 401(k) accounts.
What Are the Benefits of a 401(k) to Employees?
These days, most private-sector employers prefer defined contribution plans like the 401(k) to the traditional pension that the company entirely funded. The pension plan was a monthly payment for life, in an amount based on the employee’s tenure and salary history. Aside from the obvious financial burden, the plan required employers to manage a retirement investing and payment system.
In contrast, 401(k)s, and other defined-contribution plans put the onus of contributing and investing on the employee. They don't guarantee (or "define") a set payout at retirement. Ultimately, this ends up being far more cost effective for the employer.
Employees can grow their savings in a tax-deferred account and multiply their savings by way of the employer’s matched dollars, which are also tax-free at the time of contribution. If you have a 401(k) matching plan as a part of your employee benefits package, it is wise to make the most of it as it is an important tool for building net worth and financial independence for your retirement years.
The IRS doesn't require matching the employee's 401(k) contributions, but many employers do so. The "company match" is a crucial selling point inside the company. A certain percentage of a firm's employees must participate for a plan to be considered legitimate by the IRS.
Typically, the company's contribution level is tiered: A generous match might include a dollar-for-dollar match on the first 3% of the employee's deposit, then 50 cents on each dollar of the next 3%, up to 6% of employee contributions in total, for example.
4.7%
The average employer 401(k) match contribution is around 5% of an employee's salary.
What Are the Benefits of a 401(k) to Employers?
Employers offer benefit programs to help employees feel valued and build financial security for themselves and their families through tax-advantaged savings. This helps to attract and retain a qualified workforce. Moreover, as more companies offer this type of plan as a standard benefit, those without it can be seen as lacking. While it can be costly for the employer to manage, oversee, and test the plan, the overriding value of offering a 401(k) match is to earn the goodwill and loyalty of employees and provide a meaningful benefit.
Employers can also deduct matched contributions from their income taxes, subject to certain limitations. In addition, elective deferrals and investment gains are not currently taxed and enjoy tax deferral until their distribution (Roth deferrals, however, are included in the employee's taxable income in the year of the deferral).
Some employers are required to maintain retirement accounts as part of state legislation. Several states have passed laws that require companies of a certain size to offer retirement plans to their employees or sign up for a private state-run program. For example, the Illinois Secure Choice Savings Program Act states that companies with at least five employees offer their own retirement program or facilitate a Illinois Secure Choice option.
13 states have passed legislation requiring employers with more than a certain number of employees to offer qualified retirement plans like a 401(k). An additional 17 states have proposed similar laws that have not yet been ratified.
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How Much Can an Employer Match in a 401(k) Plan?
For 2022, the most an employee can contribute to a 401(k) is $20,500. An employer can match can be up to $40,500 (for a maximum total contribution of $61,000 per year). Employees over age 50 can make catch-up contributions that, along with employer matches, cannot exceed a total of $67,000.
Do Most Employers With 401(k) Plans Offer Matching Contributions?
A 2021 industry survey reported that around 82% of employers studied offered a 401(k) on at least a portion of their employees' contributions. Most companies that offered a match required employees to work for at least one year before the matching begins, and most matches then are subject to a vesting schedule.
What Is the Typical Size of an Employer Match in a 401(k)?
A study by Vanguard found that the average employer match for a 401(k) in 2020 was 4.5%. If an employee's eligible compensation was $100,000 and the company provided a 100% match up to 4.5%, the employee would contribute $4,500 and the company would contribute $4,500.
The Bottom Line
The employer match also is an attractive benefit for recruitment. If an employee has offers from more than one company and all else is equal, the 401(k) contribution matching could become a factor in choosing one firm over another.
Also, employers receive tax benefits for contributing to 401(k) accounts. Specifically, their matches can be taken as deductions on their federal corporate income tax returns. They are often exempt from state and payroll taxes as well.
Correction—June 16, 2022: The article has been corrected from a previous version that mistakenly referenced the 4.5% average contribution rate as the employer match percentage in an example. In fact, a 4.5% contribution rate is of the employee income, not the match percentage.
