Understanding Matching Contributions
Receiving matching contributions to your retirement plan from an employer is one of an employee’s best benefits for making the most out of their 401(k) plan. In addition, maximizing matched contributions will help grow your retirement plan faster.
What is a Matching Contribution?
Essentially, a matching contribution is the amount given by an employer whenever you contribute to your retirement plan. For example, suppose you use a 401(k) plan as a retirement savings vehicle. Your employer would make a matching contribution for every contribution you make to the plan in such a case.
Every employee contributing a specific percentage of their income to their chosen retirement plan will receive a match from the employer for the same amount. An employer’s matching contribution is essentially free money for the employee since they do not earn it themselves.
How Matching Contributions Work
A typical example of a matching contribution occurs through a 401(k) retirement plan. Under this plan, an employee contributes a certain percentage of their income to a designated fund to get future retirement benefits and tax advantages on the contributed amount.
For example, an employer’s matching contribution can be 50% of an employee’s contribution, limiting to 6% of their salary.
Suppose your annual salary is $40,000, and you contribute $2,000 towards your 401(k) plan every year. Then, your employer’s matching contribution would be 50% of your contribution, i.e., $1,000 (50% of $2,000), subject to a cap of 6% of your annual pay, i.e., $2,400 (6% of $40,000).
Matching contributions are not legally required, and not all employers provide this benefit. Still, it is usually the norm for employers to provide some matching contribution to boost an employee’s retirement benefits.
What Plans Are Available?
You can find matching contributions usually in 401(k) plans, although other retirement benefit programs, like simple IRAs, make use of them.
401(k) plans are primarily two types:
- Traditional 401(k) Plan. Traditional 401(k) plans require contributing a certain percentage of your income to a designated fund. Your employer then makes a matching contribution towards the account to fulfill the plan’s purpose.Matching contributions can be:
- A partial match. The maximum contribution by employers caps at a specified percentage of an employee’s annual income. Often, a matching contribution made is 50% of employees’ contribution, subject to a limit of 6% of their yearly pay. However, the exact employee matching terms can vary by plan.
- A dollar-for-dollar match. In this case, employers’ contribution is 100% of an employee’s contribution, limited to a percentage of their annual pay. For example, your employer can contribute 100% of your contribution with a cap of 4% of your yearly pay.
- A non-match. These contributions, though rare, are made by employers on a profit-sharing basis, based on achieving particular business objectives. They are also limited to a specified percentage of an employee’s annual pay.
- Roth 401(k) Plan. In a Roth 401(k) plan, you contribute a specific percentage of your income after deducting taxes.In this plan, tax deductions occur before contributing to the fund. To provide matching contributions for a Roth 401(k) plan, employers need to create a separate traditional 401(k) account.
According to this plan, employees make contributions post taxes, while employer contributions are charged taxes at the time of withdrawal.
Maximizing Your Matches
When you choose to contribute to a 401(k) plan, a matching contribution by your employer can allow you to multiply your savings to meet your retirement goals.
You can take the following steps to make the most of the contributing matches:
- Start contributing early. Most companies will give you the full benefit of the plan when you start contributing early. However, some companies allow matching contributions by employers after a specific tenure of service.
- Get the full match from your employer’s contribution. Matching contributions from employers are primarily extra money for contributing to a 401(k) plan. Make contributions to ensure that you get the full match from your employer’s contribution.
- Set your contribution on automatic mode. Set your contribution on automatic mode to pay yourself first before incurring other expenses. This simple step will allow you to save consistently for your retirement in the future.
- Avoid dipping into your retirement savings. Saving for retirement is a long-term habit. You might dip into your fund to spend on some other immediate expenses, but that can eat away your future security in the long run.
Your employer’s matching contribution to your 401(k) plan provides you with free money that can help secure your retirement in the long run. So make sure to contribute to get the maximum advantage out of it.