Curious about how 401K matching works? You’ve come to the right place. Today, we’re going to take a deep dive into the matter to help you gain a clear understanding of how you can make the most of this type of retirement account.
Retirement planning can be tricky – especially if you aren’t familiar with the different options available out there to help you reach your goals. Once you lose that income that comes from your job, it can be hard to keep up with bills and other expenses. That is why you cannot overlook the importance of how you save for retirement.
There are a lot of saving opportunities to consider when it comes to retirement. However, a popular option is a 401(k) plan. And the beauty of this particular plan is that your employer matches your contributions in some cases – helping you supercharge your retirement savings and enjoy the lifestyle you want to live after 60.
Ready to discover how a 401K match works? Keep reading – we’ll start with a brief overview of what 401K plans are first.
What are 401(k) Plans?
401(k) plans are retirement investment accounts that employers offer to their employees. These plans use the funds that are deposited into them towards investments. That means they can grow! The best part? Sometimes an employer contributes the same amount that an employee puts in.
Other times, they may choose to contribute a partial amount or none at all. It just depends on the employer! The funds that employees put in are known as contributions while the funds they take out are known as distributions. Basically, these are just fancy terms for saying deposits and withdrawals. The funds that are deposited into the account can go towards a variety of investment options. There are two main types of accounts when it comes to 401(k) plans. There is a:
- Traditional 401(k)
- Roth 401(k)
Regardless of whether it is a Traditional 401(k) or a Roth 401(k) there are still some rules that apply. For example, there are contribution limits that people must follow. In 2021 the contribution limits for a 401(k) were:
- $19,500 for people younger than 50 years old
- $26,000 for people older than 50 years old
It’s also important to keep in mind that contribution limits for 401(k) plans can change every year! For example, in 2022 the contribution limits are:
- $20,500 for people younger than 50 years old
- $27,000 for people older than 50 years old
Different Types of 401(k) Accounts
As we said earlier there are two main types of 401(k) accounts. It is important to understand the difference between these two accounts especially since each option comes with its own set of pros and cons.
What is a Traditional 401(k)
Let’s start off by getting a better understanding of what a Traditional 401(k) account is. This type of account uses pre-tax dollars. Since the account uses pre-tax dollars, that means the contributions can be seen as a tax deduction! This would reduce the overall amount of taxable income that you are responsible for (only for the year that you deposit the funds).
For example, let’s say you made a deposit of $1,000 in 2021 and your income for 2021 was $51,000. You could get a $1,000 deduction and only be responsible for paying taxes on $50,000. For this type of account, there are rules that are important to remember (besides the contribution limits listed above). For example, you will have to take out the required minimum distributions (RMDs) once you are 72 years old.
It’s important to especially pay attention to the tax side of things when learning about a Traditional 401(k). Since employees will get the tax benefit when they deposit funds, they will need to deal with taxes later on down the line. When you make a withdrawal (known as a distribution), you can expect the funds to be taxed at the standard income tax rate. Learn more in our article addressing the question – is 401K subject to FICA?
What is a Roth 401(k)
Now that you have a better understanding of a Traditional 401(k), let’s take a deeper look at a Roth 401(k) account. Unlike a Traditional 401(k), these accounts are funded with after-tax dollars.
That means taxes (like income taxes) have already been applied by the time that an employee makes a contribution. However, even though a person may not see tax benefits right away, they will see them down the line once it’s time to take out a distribution. That’s because the funds taken out of this type of account are not subject to any additional taxes!
If you want to learn more about the different types of 401Ks, take a look at our article – are IRA and 401K the same? For now, we’re going to get into the topic you came here to learn about: how a 401K match works.
How 401(k) Matching Works
Ready to discover how 401K matching works – and how your employer matching contributions can help you reach your retirement savings goals faster than alone? Below, we’ll talk all about how 401K matching works.
One of the biggest benefits that come along with this retirement savings option is the fact that employers may match or partially match the contributions you make into your 401K account. It’s basically like free money going into your account! However, many people aren’t familiar with how these accounts work, especially when it comes to matching. It’s important to keep in mind that 401(k) plans will vary by employer. That means how they handle matching an employee’s contribution can be different. And, employer matches aren’t necessarily guaranteed – although they are becoming increasingly common.
Usually, you can expect to see your employer match a percentage of employee contributions up until a specific portion of the overall salary. Another common way that employers handle 401(k) matching is by choosing to match employee contributions up until a certain dollar limit (instead of looking at the employee’s salary).
We know we may sound like a broken record but understanding 401(k) accounts can be confusing – so repetition is key! Since this plan can be different from one plan to the next depending on the employer, you will want to confirm with your employer on specific terms of the option they provide. However, both you and your employer will need to follow the contribution limits that are set (the same ones we spoke about earlier!).
How 401(k) Match Works: Real-Life Examples to Help You Gain a Clear Understanding
Hopefully, the section above helped you gain a better understanding of how 401K matching works. However, the manner in which your employer contributions are made can still get pretty confusing. So, let’s take a look at an example to get a better understanding of how you may see an employer match your 401(k) contributions.
For example, let’s say that your employer will match 100% of your contributions every year up to a certain dollar amount. The limit they set is $4,000. That means, if you contribute $5,000, they will only contribute $4,000 even though they technically contribute 100% of what you put in. That’s because of the limits they have in place!
Let’s take a look at another example. More commonly, employers will follow a partial match setup. For example, let’s say your employer matches 50% of your contributions. That means if you contribute $5,000 to your 401(k), they will only contribute $2,500.
Understanding a 401(k) Vesting Schedule
Another important factor to be aware of when it comes to how 401k matching works is the plan’s vesting schedule. A vesting schedule determines how much ownership you have of employer contributions.
This depends on how many years you have been an employee. It’s important to keep this in mind because you may forfeit some (or even all) of your contributions if you no longer work for that employer before a specific number of years have passed.
Frequently Asked Questions (FAQs) About How Employer Matching Contributions to Your 401k Works
You should now feel confident in how 401K matching works. However, maybe you have additional questions about employer contributions to your 401K plan – or questions about 401k plans in general. Explore below as we address some of the most frequently asked questions about
Does Every Employer Match Your Contributions?
Not necessarily! The extent to which an employer matches employee contributions depends on the company. Each employer will have its own rules and terms of the 401(k) plan they offer its employees. However, it is not uncommon to see employers provide partial matching or even full matching (up to a specific limit). As you start your job search, you’ll want to find a company that offers an employer match to your 401K.
Is Dollar for Dollar Match Common?
When there is full 401(k) matching (instead of partial matching), that means contributions are matched dollar for dollar on what employees put in (up until limits are met). Every employer is different but it can be hard to find plans that don’t offer partial matching since they provide so much support.
Are Employer’s Matching Contributions Going Past Limits?
No! When looking at employers’ matching contributions of their employees, they will still be limited by the IRS limits even if they have none themselves. The best way to confirm what limits you may encounter is by checking with your employer specifically.
Final Thoughts on How 401K Match Works
We hope this article helped you gain clarity on how employer matching contributions to your 401K account works. In summary, matching contributions is something most employers will do – at least to a certain extent. The exact amount your employer matches your contributions to a 401K account varies from job to job. That’s why this is an important conversation to have when seeking employment. If you can find an employer that will match your 401K contributions dollar for dollar – or even partially – then yes, 401Ks are worth it!