Employees benefit from their employers offering 401(k) plans with employer-matching contributions because they’re receiving additional money in their retirement fund. But how do employers benefit from matching contributions?
Some of the benefits employers may realize by offering matching contributions include:
Greater tax savings. The administrative expenses associated with a 401(k) plan — including any employer contributions, such as matches and profit-sharing — are tax-deductible expenses.
Improved recruiting. Offering a 401(k) plan that has an employer match can help attract and retain talented and loyal employees.
Employee incentive. Employers can tie employer-matching contributions to meeting specific company goals. Employees may receive more through their commitment to the company’s bottom line.
Increased plan participation rate. Providing an employer match gives more incentive to employees to participate in the plan.
In addition, by offering a 401(k) plan for employees, an employer/owner can benefit his or her own financial future for retirement. For example, generally owners are considered highly compensated employees, and depending on plan design and demographics, a 401(k) plan could enable employees in this group to save up to the IRS maximum in a defined contribution plan. In 2013, the maximum is $51,000 (and an additional catch-up contribution of $5,500 for those who are 50 or older).
Generally, employers aren’t obligated to match contributions in 401(k) plans. However, if an employer provides a match, it must be noted in the plan document. In addition, employers can decide to end a discretionary match at any time.
Employers should compare administrative costs and other fees associated with the several different plans to make an informed decision about which provider to choose. Then, employers must determine what type of plan design and employer match will work best for their given situation.
One of the most popular employer-matching contribution formulas is 50% of deferrals up to 6% of compensation. Some employers offer more generous match formulas, such as dollar for dollar.
Usually, the employer-matching contribution is made at each payroll period or annually. Again, the decision on how to make the match must follow the plan document provisions. If the match is an annual match, the employer has until the due date of the plan’s tax return, with extensions, to make the deposit.
One way to help employers retain employees and to help employees to not lose employer-matching contributions is to put a vesting schedule on the contributions. How does this help employers? It allows them to give the money to their employees, but if the employee doesn’t stay in their employ long enough, they may not have to give all of the employer-match money to the employee when employment terminates.
A vesting schedule requires an employee to work a certain number of years to get a percentage of the money at termination of their employment. A vesting year is earned by working one year, with at least 1,000 hours. A popular vesting schedule is known as a “six-year graded.” A six-year grade means that, with one vesting year or less, the employee isn’t vested in any of the matching contributions. At two years, the employee is vested in 20%; at three years, 40%; at four years, 60%; at five years, 80%; and finally at six years, the employee vests in 100% of the matching contributions.
For example, if an employee with two years of service terminates, he or she receives only 20% of the total employer match. The remaining 80% is forfeited, and depending on the document provisions, the employer may be able to use this money to reduce future employer contributions or to pay administrative expenses for the plan, or both.
Make the match
Matching contributions can boost your employee participation and provide a tax deduction. Consult your benefits specialist to review the options and determine which matching and vesting schedule is right for you.
Vesting rules in safe harbor matching plans
Safe harbor matching plans differ from 401(k) plan matching plans. Unlike a regular 401(k) plan, the employer must match each year to get the safe harbor status, which allows the employer to automatically pass actual deferral percentage / actual contribution percentage (ADP/ACP) testing. Employers still have the option to decide whether they’ll make the safe harbor matching contribution, but by opting out, their plan is subject to ADP/ACP testing for that particular plan year. Also, keep in mind that safe harbor matching contributions are immediately 100% vested.