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How Does 401k Matching Work?

401k plans are one of the most common investment vehicles that Americans use to save for retirement.

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.

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Whether you’re on your first job or are thinking about retirement, there are a few things you need to know about employers matching your 401k contributions. 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. Similarly, some employers use 403b or 457b plans. The type of plan is based on the type of entity; 403b plans are used by tax-exempt groups, such as schools or hospitals; and 457b plans are for government workers, although there are some non-governmental organizations that also qualify to use these 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.

Tip: Read More On How You Can Max Out Your 401k in 2020

How Much Can You Contribute to Your 401k?

For 2020, 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.

But here are two common types of matches that companies usually match on:

Partial Match

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.

Dollar-for-Dollar 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.

Is There a Contribution Limit?

As I mentioned earlier, the IRS raised its 2020 contribution limit for employees who participate in 401k, 403b, and most 457 plans to $19,500. 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.

Vesting Schedules for 401k Matching

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

  1. Sign up for Personal Capital’s FREE financial tools to track your entire retirement portfolio for free, and see how likely you are to meet your retirement goals. On a mobile device? Go straight to the app store to get the free tools.
  2. Consider speaking to a fiduciary financial advisor for guidance on your retirement planning.

The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.

Any reference to the advisory services refers to Personal Capital Advisors Corporation, a subsidiary of Personal Capital. Personal Capital Advisors Corporation is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training nor does it imply endorsement by the SEC.

Jesse Piburn
Jesse has been working in financial services since 2012, beginning his career as a Financial Consultant with AXA Advisors in Denver, CO. While at AXA Jesse services a client base of individuals, families, and small businesses helping them to develop personalized strategies to meet their financial goals.
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