Finances and Taxes

The Employer’s Guide to 401(k) Matching

Courtney Buchanan  

401(k) matching is a valuable benefit that many employees look for—and often expect—from employers. When an employees’ contributions are matched by the employer, it can make a huge difference in their savings when they retire. It’s a secret weapon of sorts.

59.7 percent of small businesses add a discretionary match, according to a 2019 study by Employee Fiduciary. Yet in 2020, 11 percent of employers suspended their matching contributions, according to a report from Fidelity Investments.

What is 401(k) matching?

401(k) matching is an employee benefit that many companies offer; it’s simple: when an employee contributes to his or her 401(k), the employer matches that contribution. Typically, 401(k) matching programs have a maximum percentage of the employee’s salary that an employer contributes.

Employers can choose partial matching, dollar-for-dollar matching, or flat amount.

Partial matching

With partial matching (also known as a “stretch match”), the employer matches part of the employee’s contribution and up to a certain amount. For example, an employer may match 50 percent of an employee’s contribution and up to 4 percent of their salary. In other words, the employer matches no more than 2 percent of the total salary. In this scenario, if an employee contributes 2 percent of their salary, the employer will contribute 1 percent. On the other hand, if an employee contributes 6 percent, the employer will contribute 2 percent. 

Dollar-for-dollar matching

With dollar-for-dollar matching, the employer matches the full amount that the employee contributes up to a certain amount. For example, an employer may match dollar-for-dollar up to 6 percent of an employee’s salary. In this scenario, if an employee contributes 3 percent, the employer matches 3 percent. If an employee contributes 8 percent, the employer matches 6 percent. The most common dollar-for-dollar contributions are 5 percent or 6 percent.

Discretionary contributions

Discretionary (or blanket) contributions are exactly as they sound: the employer contributes a discretionary amount that is fixed, such as $5,000 per year, for all employees regardless of the employees’ contributions. The employer can adjust the contributions as business needs change. An employer can apply a vesting schedule to discretionary contributions to encourage tenure and reward long-term employees. 

Per the SECURE Act, long-term, part-time employees who work at least 500 hours in three consecutive years can participate in 401(k) plans and therefore would be eligible for discretionary contributions. For highly compensated employees (those who earned more than $105,000 in the prior year) and owners, they must pass the IRS nondiscrimination testing requirements to receive discretionary contributions. 

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Why is it important to offer 401(k) matching as a benefit?

The competition for talent is tough, and offering a 401(k) matching program can help you attract and retain talent. When employees are confident with their retirement savings, their job satisfaction and performance can increase. 

In fact, 80 percent of non-retired Americans say they expect to rely on 401(k) or another retirement savings account as a source of retirement income, according to a Gallup poll. 62 percent of U.S. retirees, on the other hand, say they rely on 401(k) or another retirement savings account as a source of retirement income, according to the same Gallup poll.

Matching contributions also offer a tax benefit for the employer. We’ll explore this more below. 

How much does it cost to offer 401(k) matching?

The cost of 401(k) matching comes down to your company’s specific matching program and the number of employees. For example, if an employee’s annual compensation is $80,000 and the employer offers a 50 percent match up to 4 percent of the employee’s salary with a limit of $4,000, the employer will contribute $3,000 if the employee contributes $6,000 of his or her salary, hitting the full match. 

According to Human Interest, the average annual cost of providing a 401(k) for one employee is as follows: 

  • $1,920 per employee with 10 employees
  • $2,640 per employee with 25 employees
  • $3,840 per employee with 50 employees

The long-term cost of forgoing a 401(k) match however is worth considering as well. This benefit is important for employee retention—and it can be much less expensive to offer a 401(k) match than it is to replace an employee. When an employee leaves, it often costs about a third of their annual salary to replace them. Loss of productivity and recruitment doesn’t come cheap

Is the employer contribution tax-deductible?

The employer’s matching contributions are deductible as a business expense on the federal income tax return as long as they don’t exceed the IRS contribution limits. They can also be exempt from state and payroll taxes. That is, up to 25 percent of the compensation of all eligible employees participating in the 401(k) plan is exempt. 

If you have fewer than 100 employees, you may be able to take advantage of the retirement plan’s startup cost tax credit. With the credit, an employer can deduct half of the plan’s ordinary and necessary startup costs, up to $500 per year. 

What are the compliance regulations for 401(k) matching?

An employer’s 401(k) matching contributions and an employee’s contributions combined can’t exceed 100 percent of the employee’s compensation or $58,000, whichever is less. Of that, the employee’s contributions in 2021 can’t exceed $19,500. Employees over the age of 50 are eligible for an additional $6,500. 

Some 401(k) plans, such as the safe harbor 401(k) and the SIMPLE 401(k), have employer matching requirements. The requirement for the safe harbor 401(k) is fairly straightforward: the employer must match or contribute to the employee’s 401(k). With the SIMPLE 401(k), the employer must match the employee’s contribution up to 3 percent or provide a flat contribution of at least 2 percent of their compensation. 

To ensure the 401(k) plan doesn’t discriminate in favor of employees with high compensation, employers must perform annual tests, known as the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests

How do I set up a 401(k) matching program?

You can see a step-by-step guide for setting up a 401(k) in this guide. If you already work with a 401(k) provider, you may want to call your provider to discuss setting up a matching program. If you don’t have a 401(k) provider, now is the time to contact one. 

How should I communicate the matching program to employees?

You should include the details of your 401(k) matching program in your employee handbook. While 401(k) matching may seem like a cookie-cutter benefit, there’s almost always an opportunity to reflect your company culture and values. For instance, if there’s a vesting schedule associated with your 401 (k) match and your company is “family friendly,” you may wish to clarify in your handbook that vesting is not paused when an employee is on family leave. Chat with your HR partner to ensure that your policies are equitable and inclusive.

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Courtney Buchanan
Courtney Buchanan Courtney Buchanan is a storyteller and content marketer based in San Francisco. Her area of expertise is B2B content strategy and development.

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