Home Investing What is 401k Matching & How Does it Work?

What is 401k Matching & How Does it Work?


Key Takeaways

Matching 401(k) contributions are the additional contributions made by employers, on top of the contributions made by employees.
These matches are made on a percentage basis, such as 25%, 50% or even 100% of the employee’s contribution amount, up to a limit of total employee compensation.
The maximum amount employees can contribute to their 401k in 2022 is $20,500, or $27,000 if they are 50 years of age or over.
Employer matching contributions represent a risk-free return on investment — they are the closest thing there is to a “free lunch.”

401k plans are one of the most common investment vehicles that Americans use to save for retirement. One common perk of these plans is that they may come with an employer match.

Get the Basics: What is a 401k? – A Comprehensive Guide 

What Is 401k Matching?

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. 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.

Learn More: The Average 401k Balance By Age

Similarly, some employers use 403b or 457b 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.

The type of plan is based on the type of entity:

403b plans are used by tax-exempt groups, such as schools or hospitals.
457b plans are for government workers, although there are some non-governmental organizations that also qualify to use these plans.

Whether you’re on your first job or are thinking about retirement, here are a few considerations to keep in mind when offered an employer match to your 401k contributions.

How Much Can You Contribute?

For 2022, you can contribute up to $20,500, and an additional $6,500 if you are age 50 or older, or a total of $27,000. Note that 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.

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.

Following are two common types of company contributions.

1. Partial Matching

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. 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.

2. Full 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.

401k Vesting Schedules

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. Vesting refers to how much of employer contributions actually belong to you — it is based on how long you’ve worked at the company.

What this means is 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. So if you were to leave your employer or be terminated before the vesting period is over, you might lose some or all of the employer contribution.

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.

Matching Roth 401k Contributions

Some employers offer what is referred to as a Roth 401k in addition to a traditional 401k. Contributions to a Roth 401k are made with after-tax money, or in other words, money that you’ve already paid taxes on. Traditional 401k contributions are made with pre-tax money, or money that you haven’t paid taxes on yet.

What this means from a practical standpoint is that you can withdraw money from a Roth 401k tax-free after you retire. With a traditional 401k, you’ll have to pay income tax on withdrawals in retirement. However, traditional 401k contributions (or deferrals) reduce your current taxable income, which reduces your current taxes — Roth 401k contributions don’t do this.

The contribution limits for Roth 401ks are the same as for traditional 401ks: up to $20,500 in 2022, or $27,000 if you’re 50 years of age or over. Unlike Roth IRAs, there is not an income limit for participating in a Roth 401k. Note that employer matches to Roth 401k accounts are made into a traditional 401k.

Frequently Asked Questions

Here are a few commonly asked questions about 401k matching:

Q: What is considered a good 401k match?

A: The best 401k match would be a 100% match up to the allowable limits. But any match is generally considered good since it represents a risk-free return on investment.

Q: What does 6% 401k match means?

A: This means that the employer is matching up to a total of 6% of an employee’s overall compensation to his or her 401k account on top of what the employee is contributing. So if an employee is earning $50,000 per year, the employer’s match would not exceed $3,000.

Q: Is a 401k worth it with matching?

A: Every employee must decide if participating in a 401k plan is worthwhile given that person’s unique financial situation. However, an employer match usually makes participating and contributing at least enough money to receive the full employer match more attractive.

Q: What is a 401k matching example?

A: Suppose an employee earns $50,000 annually and decides to contribute 10% of his pay to his 401k account, or $5,000 per year. Now suppose his employer matches 100% of employee contributions up to 6% of salary. The employer would make a matching contribution of $3,000. If the employer made a 50% match, the match amount would be $2,500.

Q: How do Roth 401k matching contributions work?

A: When employers make matching contributions to a Roth 401k, the money goes into a separate traditional 401k account, not into the Roth account. This is due to the tax treatment of Roth funds.

Suggested Next Steps for You

If you are not able to max out your 401k contributions, then the best strategy may be to contribute the minimum amount required to take advantage of your employer’s matching contributions.

Here are some steps you can take now, and for free, to help you manage and evaluate your 401k.

Analyze your retirement readiness. Personal Capital offers a tool called the Retirement Planner, which allows you to see how likely your current portfolio and retirement plan are to be successful. You can test out different scenarios to see how different expenses or timelines may impact your retirement plan.
Read up. The free guide 65 Ways to Retire Smart offers actionable insights for getting yourself on track to retirement.
Make sure you analyze how much you are paying in fees in your 401k. Personal Capital’s Fee Analyzer tool will help you spot any hidden or excessive fees.
Consider speaking to a fiduciary financial advisor for guidance on your retirement plan.
Try out this calculator to see if you’re on track to the retirement you want.

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