- An employer match makes a significant difference in retirement savings over time
- Only 4% of all 401(k) plans do not provide an employer match
- Only 64 percent of 401(k) plan participants contribute at least enough to qualify for the maximum employer match available
Not all 401(k) plans are the same, so how can you tell if you have a good one?
There are a number of features that make a difference in the quality of 401(k) plans -- everything from investment menus to fees to retirement planning tools. However, no element of a 401(k) plan makes as much of an immediate difference as the employer contribution.
The employer contribution is the amount of money your employer puts into the plan on your behalf. In some cases, the employer contributes nothing; in other cases, employer contributions are fairly generous. The following discussion will help you evaluate how generous your 401(k) plan is, and how this should affect your participation in the plan.
Employer contributions to 401(k) plans - how do they work?
In general, 401(k) plans depend primarily on money put into them by the workers themselves (i.e., you can choose to defer a portion of your wages to the plan, up to certain limits). In return, you receive an immediate tax deduction plus tax-free investment growth, though you will ultimately have to pay taxes on the money when you withdraw it from the plan in retirement.
Employer contributions sweeten the pot. This is money your employer kicks in to the 401(k) plan on your behalf. These contributions can be either matching or non-matching. A non-matching contribution means that the employer contributes to your 401(k) balance whether or not you direct any of your wages into the plan.
A matching contribution means that the employer only contributes some portion of what you put into the plan. The employer contribution is based on a percentage of your contribution, and these matches are often capped (meaning that they only apply up to a certain amount of your salary).
Example: Suppose you make $50,000 a year and your employer offers a 50 percent match on contributions up to 5 percent of your salary.
If you choose to direct 4 percent of your paycheck, or $2,000 a year of your $50,000 income, your employer will kick in half as much on top of your contribution -- 2 percent, or $1,000 a year.
However, in this example, if you directed 6 percent of your paycheck into the plan, the employer would only give you a 50 percent match on 5 percent of your pay, because of the 5 percent cap on matching contributions.
|Annual Salary||Employee Contribution %||Employee Contribution||Employer match %||Employer match||Combined Contribution|
|$ 50,000||0.01||$ 500||50%||$ 250||$ 750|
|$ 50,000||0.02||$ 1,000||50%||$ 500||$ 1,500|
|$ 50,000||0.03||$ 1,500||50%||$ 750||$ 2,250|
|$ 50,000||0.04||$ 2,000||50%||$ 1,000||$ 3,000|
|$ 50,000||0.05||$ 2,500||50%||$ 1,250||$ 3,750|
|$ 50,000||0.06||$ 3,000||50%||$ 1,250||$ 4,250|
|$ 50,000||0.07||$ 3,500||50%||$ 1,250||$ 4,750|
|$ 50,000||0.08||$ 4,000||50%||$ 1,250||$ 5,250|
Do most employers match 401(k) contributions?
There are several variables to look at when trying to figure out whether or not a 401(k) plan is generous. Is the employer contributing anything? Is it a matching or a non-matching contribution? How much of your contribution is matched, and is the match capped?
Start with perhaps the simplest question: Should you expect your employer to contribute anything?
The answer is yes.
According to Vanguard (a prominent 401(k) plan provider), 44 percent of all plans provide just matching contributions and another 41 percent provide both matching and non-matching contributions. In the latter scenario, the employer will contribute something on your behalf no matter what, but you can increase that contribution if you direct some of your paycheck into the 401(k) plan to earn a match as well.
In total, 85 percent of 401(k) plans provide some form of matching contributions. Another 11 percent of plans provide just non-matching contributions.
What all this adds up to is that only 4 percent of 401(k) plans provide no form of employer contribution. If you are in one of those, you are in one of the least generous 401(k) plans around.
What is a good 401(k) match?
If your employer makes non-matching contributions, you are really ahead of the game -- that's extra money you get as long as you are eligible for the plan. When it comes to matching contributions, though, the amount you get out of your employer depends on how much you put into the plan. So what's a good 401(k) matching contribution?
According to Vanguard's data, the most common matching formula was 50 cents from the employer for every dollar contributed by the employee, up to the first 6 percent of the employee's pay. However, there are many varieties of matching formulas out there, plus some employers kick in non-matching contributions as well.
Looking at the average maximum employer contribution available as well as the average amount the employee has to contribute to get that maximum, a picture appears of what is considered to be a reasonably generous 401(k) plan. On average, 401(k) participants can get employers to contribute up to 4.2 percent of wages, and participants have to contribute an average of 7.0 percent of wages in order to get that maximum contribution.
If your employer provides more than that, you should consider yourself to have a pretty generous 401(k) plan.
Why an employer match is so important
The details of employer matching programs make a difference. Consider two employees, Jane and Jack. Each makes $50,000 and contributes 6 percent of that annually to their company 401(k) plan. They each earn similar investment returns of 5 percent a year. However, Jane's employer has a 50 percent match, while Jack has none.
At the end of 20 years, Jane would have accumulated $152,517 in her 401(k) plan, while Jack's balance would be worth $50,839 less, at $101,678. Remember, both of them contributed the same annual amounts and earned the same investment returns, but the existence of an employer match made a significant difference in their retirement savings.
How this should impact your 401(k) deferral strategy
The purpose of an employer match is to get employees to contribute to their 401(k) plans. Vanguard's figures suggest this is fairly successful -- 64 percent of 401(k) plan participants contribute at least enough to qualify for the maximum employer match available from their plans. The flip side, though, is that this means over one-third of plan participants are not contributing enough to maximize the money they could be getting from their employers.
Here's how to take full advantage of a 401(k) match and build retirement savings:
- Contribute enough to qualify for your employer's match
Your minimum goal as a 401(k) plan participant should be to make sure you don't leave any employer dollars on the table by failing to take full advantage of your plan's matching program. Find out what the maximum match on your plan is, and make sure you contribute enough to qualify for that match.
- Reach the maximum contribution per year (2019: $19,000, under age 50 / $25,000, age 50 and above)
Beyond that, though, there would most likely still be tax advantages and retirement saving benefits to be had by contributing more than you need to qualify for the full employer match. According to Vanguard, 46 percent of employees do this, making contributions that go beyond what is necessary to qualify for the full employer match available.
In most cases, you can contribute up to $19,000 to a 401(k) plan for 2019 (and up to $25,000 if you are aged 50 or over). Chances are this is well above what you need to contribute to maximize your employer match, but your goal should be to come as close to this limit as possible. Doing so will enhance your tax savings and build your retirement nest egg more quickly -- and your employer match should help as well.
|Employer contribution||The amount of money your employer puts into the plan on your behalf.|
|Non-matching contribution||A non-matching contribution means that the employer contributes to your 401(k) balance whether or not you direct any of your wages into the plan.|
|Matching contribution||The employer only contributes some portion of what you put into the plan.|
The employer contribution is based on a percentage of your contribution, and these matches are often capped (meaning that they only apply up to a certain amount of your salary).
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