401k plans are one of the most common investment vehicles that Americans use to save for retirement. One common perk of these plans is that they may come with an employer match.
What Is 401k Matching?
For most employees, a defined contribution plan is one of the primary benefits offered by their employer, with a 401k being the standard employer-sponsored retirement plan used by for-profit businesses. Employer matching of your 401k contributions means that your employer contributes a certain amount to your retirement savings plan based on the amount of your annual contribution.
Similarly, some employers use 403b or 457b plans. While there are some minor differences between these plans, they are generally treated in a similar manner, and they usually have the same maximum contribution limits. The type of plan is based on the type of entity:
Whether you’re on your first job or are thinking about retirement, here are a few considerations to keep in mind when offered an employer matching your 401k contributions.
For 2021, you can contribute up to $19,500, and an additional $6,500 if you are age 50 or older.
When it comes to matching, specific terms of a 401k plan can vary widely. Your employer may use a very generous matching formula, or choose not to match employee contributions at all. Additionally, not all employer contributions to an employee’s 401k plan are the result of matching. Employers may make regular deferrals to employee plans regardless of employee contributions, though this is not particularly common.
Make sure you check your employer’s plan documents for the details on exactly how your 401k works.
Following are two common types of company contributions.
1. Partial Matching
A partial match means that your employer will match part of the money you put into your 401k, up to a certain amount. A common partial match provided by employers is 50% of what you contribute, up to 6% of your salary. So what this means in practical terms is that if you earn $80,000 per year, your contributions that will be eligible for matching are 6% of your salary, or $4,800 in this case. But since your company only offers a 50% partial match, they will match half of the $4,800, or $2,400. So to get the maximum amount of 401k match, you have to put in 6%. If you put in more, say 8%, your employer will still only match half of 6% of your salary, because that’s their max. The employer has the ability to determine the matching parameters.
2. Full Matching (100% Match)
With a dollar-for-dollar match, your employer will put in the same amount of money you do — up to a certain amount. An example of dollar-for-dollar is up to 4% of your salary. In this case, if you put in 4%, they put in 4%; if you put in 2%, they put in 2%. If you put in 6%, they still only put in 4%, because that’s their max.
Contribution Limits
The 2021 contribution limit is $19,500 for employees who participate in 401k, 403b, and most 457 plans. If you’re over the age of 50 your limit is $26,000. Employer matching contributions don’t count toward this limit, but there is a limit for employee and employer contributions combined: Either 100% of your salary or $57,000 ($63,500 if you’re over 50), whichever comes first.
401k Vesting Schedules
It’s important to understand the matching rules for your 401k plan, but it’s also important to understand the vesting schedule for employer contributions. Many people don’t realize that vesting of employer 401k contributions is generally tied to tenure at the company, which means that you may actually forfeit your employer match if you leave or are terminated before a certain number of years pass. A typical vesting period for employer 401k contributions is five years.
Remember, your contributions are earmarked for retirement, and because most contributions are made pre-tax, the IRS holds them with a tight grip. In most cases, you’ll owe a 10% penalty and income taxes if you pull the money out before age 59½. But if you make it to that finish line, you’ll have a pot of money that has grown tax-deferred. If you have questions about your 401k plan, or the options within your plan, reach out to your financial advisor.
Suggested Next Steps for You
If you are not able to max out your 401k contributions, then the best strategy may be to contribute the minimum amount required to take advantage of your employer’s contributions.
Here are some steps you can take now, and for free, to help you manage and evaluate your 401k:
This content was originally published here.