Maximize the Employer Matching Contribution in Your 401k

By Clifton Linton
Senior Writer

GET FREE MONEY!

If you saw an ad like that, you'd probably ask, "what's the catch?"

This is strictly on the up and up. Your employer may give you money every time you contribute to your 401k plan, if it offers a matching contribution.

"No fair," you may say. "That's like telling me to eat my vegetables before I can have dessert."

Yep.

Sorry, but a little character-building never hurt anyone. Besides, would you leave a $100 bill lying on the street? Taking advantage of your employer's match may mean that you can retire sooner, or that retirement might be nicer than you originally expected.

Some workers don't take full advantage of the matching contribution their employer offers. According to the Profit Sharing/401k Council of America's latest survey of profit-sharing and 401k plans, more than 20 percent of employees don't contribute to their plans. Not all of those employees are in plans offering a match -- about 78 percent of plans offer some kind of matching contribution, the PSCA said. Also, the figure doesn't count workers who contribute to their plans, but don't put in enough to get the entire employer match.

Your employer is not required to make any contribution to your plan at all. So, why pass on its generosity if it does offer one?

To get the full benefit of the match, it helps to know your plan's rules, including when and how to contribute. Here's what you need to know.

Get Matched
Many folks on a tight budget may think they can't afford to save for retirement. And an employer match may not seem generous enough to make it worth their while.

We repeat: IT'S FREE MONEY !

But, there's more to it than that. Consider the tax advantages. Here's an example to show how saving in a 401k with a matching contribution is affordable and profitable.

Suppose you are single and earn $30,000 a year. That puts you in the 27.5 percent tax bracket. For every dollar you earn you must pay 27.5 cents in taxes, leaving you 72.5 cents to spend as you want.

Suppose you save that same dollar in your 401k plan. Because 401k contributions are made on a pre-tax basis, the full dollar goes into the account. But, at the same time, you have also reduced your taxable income by $1. That means you saved 27.5 cents in taxes and got a dollar in savings, to boot.

Now, suppose your employer kicks in an additional 50 cents for every dollar you contribute. (That's a fairly common match.) Your $1 contribution is now worth $1.50.

Between the tax savings and match, saving $1 in your 401k plan gives you an extra 77.5 cents to put toward your future, that you wouldn't have had if you took the dollar as income and spent it today. (But remember, you will pay income tax on the money when you withdraw it.)

Down the road, getting a match makes it easier to have a nice retirement, said Dennis De Stefano, a certified financial planner and CPA with De Stefano Wealth Management in Maui, Hawaii.

"It means you can retire sooner than you otherwise might be able to do," he said. "You might be able to enjoy a higher quality of living."

Maxing Your Match
So, how can you have your cake and eat it too?

The easiest way is make sure you contribute enough to your 401k plan to get the full match. Most employers will only match a portion of your contributions.

A common match is for the employer to contribute 50 cents on the dollar, up to the first 6 percent of salary you contribute, according to the PSCA. Suppose your employer offers that match. If you earn $25,000 a year and contribute $1,500 (6 percent of salary) you will get the full match of $750.

If you contribute beyond $1,500, say $1,750, that's good for your retirement future, but your employer won't match the additional $250. If you contribute less than $1,500, say $1,000, your employer will only match that amount and you'll leave dessert (money) on the table.

Your summary plan description will tell you what your plan's match is, so you can adjust your contributions.

Match Game Rules: Timing
To get the most out of your employer's matching contribution, you need to know when your employer makes the contribution.

Federal rules require employers to make their contributions to your account no later than the final tax deadline, plus extensions, for the tax year. So, you might not see a match reflected on your 401k statement for months after the tax year ends. Many employers, though, make their contribution when you make yours.

Readers commonly ask whether it's worth it to make all of their 401k contributions early in the year to get ahead.

It may not be. Some employers only make a matching contribution when you contribute. If you contribute everything early in the year, and then don't contribute during later months, you may miss out on matching contributions in the months you don't contribute. Check with your benefits department to find out how and when the match is made. Then, adjust your contributions so you get the full match.

Match Game Rules: Vesting
It's also important to understand vesting rules for your employer's contribution.

Even though your employer may make the matching contribution at the same time you make yours, it may not be your property right away. While many employers make a match to entice their employees to join their company and to contribute to the plan, some require that you work at the firm a certain number of years before the match becomes your property. This is incentive to keep you on staff.

This is perfectly legal, and vesting requirements for employer contributions are common in 401k plans. However, you don't have to wait for your own contributions to vest.

David Wray, president of the PSCA, points out that many employers don't recoup the cost of recruiting and training a new employee until after they have at least two years of service. "The companies want them to stay for a while. They use the (401k) plan design to encourage people to stay longer," he said.

Plans have two types of vesting schedules: graded and cliff.

With graded vesting, you own an increasing portion of the employer contribution each year you are with your company. If your company had a five-year graded vesting schedule, you could be 20 percent vested after one year, 40 percent vested after two years, etc. By law, the longest graded vesting schedule a 401k plan can have for employer matching contributions is six years.

With cliff vesting, the employer contribution goes from zero to 100 percent vested after a set period of time. So if your vesting requirement is three years and you leave your company after two years, you won't get any of the employer contributions. Currently, the longest cliff-vesting schedule allowed by law for employer matching contributions is three years.

Because you may have to wait for your employer matching contribution to vest, you may want to delay a job change if you are a short time away from vesting.

Why Employers Match
Employers offer matching contributions for several reasons. The primary one is to get employees to participate in the plan, Wray said. (It's like your employer promising to give you dessert if you eat all your vegetables.)

Without a match, fewer folks are willing to save in the plan, said Trisha Brambley, president of Resources for Retirement Plans Inc., a 401k plan consulting firm. Recently, three of her clients -- employers sponsoring 401k plans -- asked her to help them figure out how much they would save if they cut back or eliminated their matching contributions for employees.

She ran some figures. They showed the dollar savings, but Brambley also told her clients what the figures didn't show -- that plan participation usually drops without a match. "You won't lose participation ... immediately. You would lose it over time," she said. "People need an incentive to save."

Ultimately, one client decided to drop its matching contribution, but two clients decided to keep theirs in place.

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.