Small Business Hiring Guide

17. How Employer Contributions to 401(k)s Work

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How Employer Contributions to 401(k)s Work

Jul 25, 2023 • 10 min read
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      Employers are offering workers an array of benefits these days, from coffee and snacks to paid time off for volunteering. Most employees seek out companies that are willing to go the extra mile for workers. However, there is one traditional benefit that employees continue to value—the 401(k).

      Employer contribution to the 401(k) has been a long-standing offer by most small and large companies. In most cases, both employees and employers contribute to the retirement benefits savings plan, which is typically tax deductible.

      1. How 401(k) matching works.

      Employers often contribute to an employee’s 401(k) through matching funds. That means that the amount of money put into the accounts by the company is based on how much the employees contribute.

      Depending on the terms of the 401(k) plan, employer matching contributions may be based on a percentage of employee contributions up to a certain portion of the employee’s total salary. However, employers may also match employee contributions up to a certain dollar amount, regardless of the worker’s salary.

      Some employers opt to match 100% of the contributions of their employees up to a certain percentage of their employees’ salaries. Others match only up to a certain amount of employee contributions.

      2. Are employer contributions mandatory?

      No, employers are not legally required to contribute to the majority of 401(k) plans if they offer them unless they are a specific type of 401(k) as described below. 

      If the 401(k) is an Automatic Enrollment plan, then the employer must make:

      • A matching contribution of 100% of salary deferrals up to 1% of compensation and a 50% match for all salary deferrals above 1%, but no more than 6% of compensation; or
      • A nonelective contribution of 3% of compensation to all participants.

      If the employer offers a SIMPLE 401(k) plan, then they must make:

      • A dollar-for-dollar matching contribution, up to 3% of pay; or
      • A nonelective contribution of 2% of pay for each eligible employee.

      There are several other requirements regarding contributions by employees and employers. Both parties should consult a financial advisor when determining how much they should contribute to maximize their retirement savings plans.

      3. Do I have to offer 401(k) to employees?

      Employers are not required to offer 401(k) plans to their employees. It is an optional benefit that many organizations offer because employees seek opportunities to contribute to a retirement savings plan. However, if an employer does offer a 401(k) plan, they must follow certain rules about which employees are eligible to participate.

      Eligibility requirements for plan participation may include an employee’s age and length of service with the employer. Employers may also differentiate between full- and part-time employees.

      4. How much can employers contribute to 401(k) plans?

      An employer may decide how much they contribute to a 401(k) up to a certain amount. However, there are some 401(k) employer contribution rules. Those can be reviewed above or on the IRS website.

      Most employers match the employee’s contribution up to a certain amount. The most common contribution percentages are between 3% and 6%. However, those amounts may be different, depending on the specific details of the 401(k) plan.  

      For example, if an employee makes $100,000 per year and they contribute 3% of their annual income to their 401(k) plan, then that would be $3,000 per year. If the employer matches contributions up to 3%, then they would also contribute $3,000 per year to that employee’s retirement savings account.

      5. Are there contribution limits to 401(k) plans?

      Yes, there are contribution limits to 401(k) plans for both employees and employers. All of an employer’s retirement savings plans are subject to an overall annual limitation that amounts to the lesser of 100% of the employee’s compensation or specific amounts determined each year by the IRS.

      6. Do employees have to contribute to a 401(k) plan?

      No, employees are not required to contribute to a 401(k) plan, even if they are automatically enrolled by their employer. If they choose not to participate, the employer may still opt to contribute to the retirement savings plan, even if the employee is not.

      7. Can an employer contribute to a 401(k) if the employee does not?

      Yes, employers can make non-matching contributions to an employee’s retirement savings account. Companies often do this if revenue and profits have been exceptional for a period of time. There are often tax benefits for both the employee and the employer to contribute these additional funds to the 401(k) rather than paying them out as a bonus or wage increase.

      8. When do employers contribute to 401(k) plans?

      If an employer matches an employee’s contribution to 401(k) retirement plans, they typically do so at the same time that the employee contributes. That is most often every pay period. However, some employers opt to make lump sum contributions at various times of year, such as quarterly or annually.

      Employers may also elect to make regular deferrals to employee 401(k) plans, regardless of employee contributions. However, that is not as common as employee matching.

      9. 401(k) plan vesting schedules.

      Parties involved in 401(k) plans should also be versed in vesting schedules. A vesting schedule determines the amount of ownership that the employee has in employer contributions. Vesting schedules are typically based on length of time of employment.

      Employees are always 100% vested in the amount of money they contribute to their 401(k). That means that they own all that amount, and they can withdraw it according to the terms of the plan.

      However, many 401(k) plans give workers a percentage of ownership that increases with the employee’s tenure with the company. For example, an employee may be vested in 25% of the employer contribution until year one of employment, then 50% at year three, and 100% at year five. The average number of years it takes to become fully vested is five. The percentages and steps vary, depending on the plan.

      10. Employer contributions to 401(k) Plans can benefit everyone.

      Employer contributions to 401(k) plans are essentially offering free money to employees. However, the practice also benefits employers. It helps companies attract better talent and retain great employees.

      If your business is considering offering a retirement savings plan to employees, you should consult with a financial expert or business lawyer who can offer advice about plan specifics. When you review plans offered through various 401(k) plan managers, those providers will often give you basic information. However, you will want to do some additional research to determine if 401(k) plan contributions are within your budget and how they can benefit your employees.

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      About the author
      Brandy Abalos

      Brandy Abalos is a licensed attorney, content strategist, and marketing consultant for small businesses. She uses SEO tools to develop strong digital content for audiences who are learning how to navigate complex topics in law and business. When she is not writing, she seeks adventures with her three children, partner, and two corgis in Ohio.

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