By offering a 401(k) plan to your employees, you provide a useful perk for working at your company and helping them save for retirement. For many, it may also influence them in accepting a job offer. Along with a retirement savings plan, employers may also offer employer matching contributions on employee deferrals. What exactly does that mean and what are the pros and cons of doing so? Let's talk about it.
What is a 401(k) Employer Matching Contribution?
Employers who offer a 401(k) retirement plan elect to participate choose to contribute a portion of their pay to their retirement savings plan. An Employer Matching Contributions means that employers will also contribute to the individual's plan. 401(k) plans can differ from company to company and the matching formula can be a uniform percentage, a fixed dollar amount, or most any formula that does not discriminate in favor of the highly compensated employees. We often see a uniform percentage formula that is either a partial or a dollar-for-dollar match.
Partial matching is matching up to a certain amount of what the employee contributes to their plan. The most common partial match is 50% of what employees contribute, up to 6% of the employee's salary. This means that you will match half of whatever the individual contributes without going over 3% of their total salary.
Dollar-for-dollar matching is a 100% match of what employees contribute to their plan up to a certain percentage. For example, a dollar-for-dollar match up to 5% means that you will match any contribution dollar-for-dollar up to this max. If an employee decides to contribute 7%, you will still match up to 5% since this is the maximum that you set.
Employee Contribution Limits
The IRS limits employee contribution amounts annually. For 2021 the limit for employees under age 50 is $19,500 and for employees who are age 50 or older the limit is $26,000. Employer matching contributions do not count toward the annual limit,however, the combined employee and employer match cannot exceed 100% of the employee's salary or $57,000, ($63,500 for 50 and older employees) whichever comes first. This combined limit is set annually by the IRS.
Pros of Offering 401(k) Matching Contributions
Attract talent by offering a 401(k) plan with matching.
Incentivize employees to stay with the company due to company match and vesting schedule.
Improve company budgeting since you will be able to adjust the match to your company's goals and financial performance.
Contributions are tax-deductible on the company's federal tax return.
Pay the match in with each payroll to reduce large payments at year-end
The Few Cons of Matching
When it comes to 401(k) matching contributions, the positives outweigh the negatives. However, with matching, there can be some downsides:
If not paid in each payroll and instead paid at the end of the year, then the beneficial impact of dollar-cost averaging is reduced
If an employee terminates employment before the employer makes the match, it may create additional administrative work
Making certain that the formula is set up properly with payroll and that the correct definition of compensation is being used when paying it in per payroll to avoid corrections being needed at year-end.
Preparing Your Employees for Retirement
401(k) retirement plans are an easy and convenient way to invest and save for retirement. By offering an employer matching contribution you are increasing the benefits even further. If you have more questions about setting up your company's 401(k) plan, contact a member of the RPSCI team today. As your retirement plan experts, we are here to help.