Using an employer-sponsored defined contribution plan — 401(k)s, 403(b)s, etc. — is one of the most effective ways to save for retirement. That’s because most employed Americans have access to one and a majority of plans offer a matching contribution in some form.
Yet many 401(k) participants could be losing out on hundreds of dollars, if not thousands, each year by not taking advantage of the matching contributions that their employer provides.
How Does 401(k) Match Work?
There are a few ways your employer could contribute to your 401(k) plan through an employer match.
Dollar-for-dollar match: Your employer will match your contributions dollar-for-dollar up to a certain percentage of your total compensation.
Stretch match: In a “stretch” contribution set up, your employer matches a percentage of your contributions up to a certain percentage of your total compensation. For example, an employer might do a 100% match up on the first 3% of your contribution and then 50% on the next 2%, for a total contribution of 4% of your salary.
Non-elective match: In this arrangement, your employer will determine a set dollar amount to contribute to each employee, regardless of whether you are contributing to the plan or not.
Check out the table below to see how an employer’s matching contributions could look based on an individual with a $100,000 salary.
Determining the way your employer is contributing on your behalf will inform how much you need to contribute in order to receive the full amount.
Under the dollar-for-dollar example, if you contribute 5% of your salary to your 401(k), your employer will contribute the same amount as you. In this instance, you might want to contribute at least 6% to take full advantage of your employer’s match program and get the extra $1,000.
Think about it this way, if you aren’t contributing enough to unlock all of your employer’s match, you are essentially throwing away free money.
Here is a handy online calculator that can help you determine the optimal amount you need to contribute in order to maximize your employer’s match.
reaching the max
Typically, you’ll want to save between 10% and 20% of your gross salary toward retirement.
The maximum that you can defer into your 401(k) personally in 2020 is $19,500 with employer matches going above and beyond that. There is also a $6,500 catch-up contribution if you are over the age of 50.
While reaching the maximum contribution level may not be a realistic goal for the majority of people based on income levels alone, it is achievable for a lot of high-wage earners who are committed to saving for retirement.
If you are one of those savers who max out their 401(k)s, there are two issues that you need to be aware of:
- If you hit the max early in the year, and
- How your employer matches your contributions – on a plan year or pay period basis
You could be leaving money on the table, depending on how your company’s 401(k) plan is set up.
Per pay or plan year?
If your employer is simply putting in one lump-sum of matching contributions for you – typically at the beginning of the following year – then there’s nothing to worry about. You are getting the full match.
The issue arises when your employer is making the matching contributions on a per pay period basis and you are maxing out the contributions prior to the end of the year.
If you are no longer contributing to the plan because you’ve maxed it out for the year, then you are no longer making contributions per pay period, which means your employer won’t be making matching contributions!
The following illustration should help clarify the point:
Annual salary = $100,000 paid monthly
Salary deferral = 24% ($24,000 per year, which exceeds the $19,500 max)
Employer match = 100% up to 6% of salary ($6,000 per year)
In the above example, you would reach the $19,500 max contribution in October. That leaves two months where you’d not be getting an employer match. That’s $1,000 you’re missing out on! In order to fix this, you would need to reduce your contribution rate to 19.5%.
Something to keep in mind is that even if your employer uses a per pay match, the plan may have a “True-Up” feature, and, at the end of the year, you will receive a full match from any missed matches during the year.
You can reach out to your HR representative or review your plan’s Adoption Agreement to find out what type of match your 401(k) plan offers and if there is a True-Up feature included.
PRO TIP: If you are already maxing out your 401(k) plan contributions, you could save even more by opening a health savings account. These accounts are about more than paying healthcare expenses, and when properly utilized, they can supplement your retirement savings now and reduce your expenses in the future.
The goal of contributing to your 401(k) is to achieve financial independence, but you want to make sure you are doing it in the best way possible.
Be aware of how your plan operates so that you can ensure you’re taking full advantage of your employer’s match.