401k: Understanding Matching Contributions

If you work for a company that provides matching contributions to your retirement plan you should try to take full advantage of it. It’s a significant benefit and you need to understand how it can help you grow your retirement funds.

What is a Matching Contribution?

Essentially, a matching contribution is the amount of money given by your employer whenever you contribute to your designated retirement plan. Most companies have a 401(k) plan as a retirement savings vehicle. When you contribute to it, your company will also contribute a certain amount. That amount varies from employer to employer, but it’s free money you will not receive if you don’t participate in the retirement plan.

How Matching Contributions Work

Let’s say your annual salary is $40,000 and you have decided to contribute five percent, or $2000 to your retirement fund every year. Your employer says it will match 50 percent of your contributions, but it will only make that match on a maximum of 6 percent of your annual salary. In this case that match would be $1000 dollars for every $2000 you contribute. Over time that money adds up, and remember, the employer match can increase as your salary increases.

The contributions employers make to your retirement fund vary and employers are not legally required to provide this benefit. Still, most employers do provide some matching contribution to boost an employee’s retirement benefits. Take advantage of it.

What Plans Are Available?

The most common matching contribution plans are usually 401(k) plans, although other retirement benefit programs, like simple IRAs, are used for them.

There are two primary types of 401(k) plans.

Traditional 401(k) Plan. These plans require you to contribute a certain percentage of your income to a designated fund. Your employer then makes a matching contribution towards the account to fulfill the plan’s purpose. Matching contributions can be:
- A partial match. The maximum contribution by employers caps at a specified percentage of an employee’s annual income. Often, a matching contribution made is 50 percent of the employee’s contribution, subject to a limit of 6 percent of their annual pay. However, the exact employee matching terms will vary by plan.
- A dollar-for-dollar match. In this case, an employer’s contribution is 100 percent of an employee’s contribution, limited to a percentage of the employee’s annual pay. For example, your employer could match 100 percent of your contribution, but it would cap off at 4 percent of your annual pay.
- A non-match. These plans, though rare, are made by employers on a profit-sharing basis and are based on achieving certain business objectives. They are also limited to a specific percentage of an employee’s pay.
Roth 401(k) Plan. In these plans, you contribute a specific percentage of your income after taxes are deducted. You then do not have to pay taxes on the income when you use it during your retirement. In order to provide matching contributions to this plan, employers must create a separate traditional 401(k) account. The employer contributions would then be taxed at the time of withdrawal, while the employee contributions would not be taxed at withdrawal.

Maximizing Your Matches

You can take the following steps to make the most out of your retirement plan and contributing matches.

Start contributing early. Most companies will give you the full benefit of the plan when you start working for them and start contributing to a plan. The sooner you get started the more you will save. You should know that some companies don’t provide matching contributions until the employee has reached a specific tenure of service.
Get the full match from your employer’s contribution. Matching contributions from employers are primarily extra money for your retirement plan. Make sure you contribute enough to the plan to get the full match from your employer’s contribution.
Set your contribution on automatic mode. If you do this the money is taken out of your paycheck automatically and put into your plan. It’s a simple step that allows you to save consistently for your retirement.
Avoid dipping into your retirement savings. Saving for retirement is a long- term habit. You may be tempted to dip into your fund for an emergency or other immediate expenses, but that will eat away your future security in the long run.

Bottom Line

Your employer’s matching contribution to your 401(k) plan provides you with free money that can help secure your retirement in the long run. Make sure you take advantage of it by contributing enough to get the full matching benefit and start saving as soon as you can.