Beyond being a remarkably attractive employee benefit in today’s hot job market, a 401(k) or 403(b) plan can incentivize employees at all career stages to save for golden years. Some hard-working Americans, however, will simply not save because they feel retirement is a long shot, or can’t afford it, or can’t grasp the benefit to making room in their budget. However, as a 401(k) or 403(b) plan sponsor, you can help change that mindset by offering an employer matching contribution, if not already.

What is a 401(k) or 403(b) employer matching contribution?

Simply put, it means that if an employee puts some money into the 401(k) or 403(b), the employer will “match” some or all of this contribution. It’s a great tool that can help businesses and organizations attract and retain top talent. Common matching formulas include:

$1-for-$1 Match:

With a dollar-for-dollar match (aka 100% match), the employer puts in the same amount of money employees do, up to a certain amount. An example might be $1-for-$1 up to 4% of employees’ salary. In this case, if employees contribute 4% of salary, the employer also puts in 4%; if employees contribute 2%, employer puts in 2%; or if employees contribute 6%, employer still only puts in 4%, because that’s their max.

For example, Sansa works for Knight’s Watch, Inc., which runs payroll on a bi-weekly basis (26 pay periods a year). Her gross pay every period is $2,000. She made an excellent decision to put away 4% of her pre-tax pay every pay period, or $80 (4% x $2,000). The Knight’s Watch, Inc. 401(k) plan generously offers a dollar-for-dollar match up to 4% of compensation deferred. With each payroll, $80 of Sansa’s pay goes to her 401(k) account on a pre-tax basis, and Knight’s Watch, Inc. also makes an $80 matching contribution to Sansa’s 401(k) account. A total of $160 goes into Sansa’s account every pay period.

At a 4% contribution rate, Sansa is maximizing the employer contribution amount. If she reduces her contribution to 3%, her company matching contribution would also drop to 3%; but if she increases her contribution to 6%, the formula dictates that her employer would only contribute 4%.

Partial Match (simple):

Let’s take the same scenario as above, but this time Knight’s Watch, Inc. 401(k) Plan matches 50% on the first 6% of compensation deferred. This means that it will match half of the 401(k) contributions. If Sansa contributes $80 to the 401(k) plan, Knight’s Watch, Inc. will contribute $40 on top of her contribution as the match. A total of $120 goes into Sansa’s account every pay period.

Tiered Match:

By applying different percentages to multiple tiers, employers can encourage employees to contribute to the plan while controlling costs. For instance, Knight’s Watch, Inc. could match 100% of deferrals up to 3% of compensation and 50% on the next 3% of deferrals. Sansa contributes 4% of her pay of $2,000, which is $80 per pay period. Based on the employer’s matching formula, Knight’s Watch, Inc. will match her dollar-for-dollar on 3% of her contribution ($60 = 3% x $2,000), and 50 cents on the dollar on the last 1% of her contribution for a total matching contribution of $70 or 3.5%.

The retirement plan’s matching formula is chosen by the employer and specified in the plan document or may be defined as discretionary. By making the matching discretionary, the employer may determine not only whether or not to make a matching contribution in any given year, but also what formula to use.

Is there a limit to how much an employer can match?

The IRS limits annual 401(k) or 403(b) contributions, and these limits change from year to year. For 2022, employee contributions are limited to $20,500 (or $27,000 if you’re 50 or over). While employer contributions do not count towards these employee contribution limits, there is a limit for employee and employer contributions combined to the lesser of 100% of an employee’s gross compensation, or $61,000 ($67,000 if you are 50 or over). It’s also important to note that the IRS caps annual compensation that’s eligible to be matched.

Potential benefits of providing an employer match:

• Attract talent: Offering a workplace 401(k) or 403(b) is a great way to set your business or organization apart from the competition, and a matching contribution sweetens the deal.
• Improved 401(k) or 403(b) plan participation: Unlike other types of employer contributions, a matching contribution requires employees to contribute their own money to the plan. In other words, the existence of the match drives plan participation up (not contributing is like leaving money on the table), encouraging employee engagement and increasing the likelihood of having your plan pass certain compliance tests.
• Financial well-being of employees: A matching contribution sends a message to your employees – that you care about their financial well-being and are willing to make an investment in their future. The additional funds can help employees secure a brighter financial future.
• Improved retention: The match is essentially “free money” that can be considered part of an employee’s overall compensation, which can be hard to give up. And don’t forget: by applying a vesting schedule to the employer match, you can incentivize employees to stay longer with your organization to gain the full benefits of the 401(k) or 403(b) plan.
• Employer tax deduction: Matching contributions are tax deductible, which means you can deduct them from your company’s income so long as they don’t exceed IRS limits.

Final words

Offering a 401(k) or 403(b) plan is already a huge step forward in helping your employees save for their retirement. Providing a matching contribution enhances that benefit for both your employees and your organization. What’s more, educating employees about its value is a key part of making the most out of your match. Data from the U.S. Small Business Administration shows that employees in small organizations contributed an average of $4,474 per year to their defined contribution plans in 2006 and had an average plan balance of $32,058. Depending on the match amount, employees’ average yearly investment could significantly increase when an employer matches at least a portion their contribution.