What is a good 401(k) match? A guide to building a competitive retirement benefit

💡 Key takeaways:

• Offering a 401(k) match could help your company recruit and retain employees.
• Your company can benefit from certain tax advantages by offering employees a 401(k) match.
• As an employer, you can choose the match formula that best suits your company, employees, and overall financial situation.
• In 2021, a Vanguard survey showed that the average employer contribution is 4.5%, while Guideline's average 401(k) match is 5.5%.

As an employer, there are seemingly more options than ever before when it comes to building a robust benefits package. These offerings range from unlimited PTO and learning budgets to travel reimbursement and pet insurance. The benefits you offer can make a big difference in recruiting and retaining employees at your company, and a major player in the benefits package is a 401(k).

401(k) plans are desirable to employees because they offer a significant opportunity to save money for retirement. What's a way to sweeten that already sweet deal? Offering a 401(k) match.

In this guide, we'll break down everything you need to know about 401(k) matching, including common matches, tax advantages, and key rules to follow to help set your plan up for success.

Understanding 401(k) matching contributions

A 401(k) matching contribution — or a "401(k) match" — is a contribution you, as an employer, make into your employees' retirement savings based on what they contribute and the requirements and formula you set up. Offering a 401(k) match is a form of compensation where you directly contribute to your employee's retirement savings plan in addition to providing salaried compensation.

There are many different formulas that employers can use when offering a 401(k) match, but some are more common than others. Here are some common types of matching formulas:

• Dollar-for-dollar: Matching each dollar an employee contributes, up to a certain maximum. For example, matching dollar-for-dollar on the first 5% of compensation an employee contributes.
• Percentage match (or partial match): Matching a percentage of an employee's contribution, up to a certain maximum. For example, matching 50% of an employee's contributions, up to 6% of compensation or 100% on the first 2% and 50% on the next 3% of compensation.

How does a 401(k) match benefit the company?

Offering a 401(k) match can benefit your company in many ways, including recruiting new hires, retaining great employees you already have, and even getting some tax benefits for your business.

Recruiting top talent

The first potential benefit of offering a 401(k) match comes in the form of recruiting prospective employees. Offering a match can set you apart from other employers, not only giving employees more overall compensation, but also showing that you value their future and want to help them successfully plan for retirement.

Retaining your employees

Another potential benefit of offering a 401(k) match is the ability to retain the valuable employees you already have. A 401(k) match can communicate to your employees that you want to contribute to their future.

Tax benefits

There are two general categories of tax advantages associated with offering a 401(k) match: a tax deduction and a tax credit.

Generally, an employer can deduct their contributions on their federal income tax return. The IRS does impose limitations on this deduction — typically 25% of eligible compensation (including any other employer contributions). For more information, check out our help center article on the deductibility of employer contributions.

Additionally, starting in 2023 small employers with newer plans may be able to claim a tax credit for making employer contributions. The eligibility criteria and formula to determine the tax credit is rather complex. Employers should talk to their tax advisor if they think they may be eligible for this credit.

What is a good 401(k) match?

Determining which 401(k) match to offer as an employer can be a delicate balance. On one hand, you may want to demonstrate your concern for your employees' financial well-being and provide them with competitive compensation. On the other hand, you may have to consider what will work with your company's priorities and financial health. There are many factors at play in this decision, but two major factors to consider are your company's budget and the overall competitive landscape.

Your company's financial picture will, of course, influence how much of a match you can offer. Taking into account the potential tax breaks you may receive from offering a match, consider how much you can afford to contribute and how much you want to prioritize this benefit. Then, get a sense of the overall competitive landscape in your industry and area to better guide your decision-making.

For context, in 2021, a Vanguard survey found that the average employer contribution is 4.5%, while the average 401(k) match for plans at Guideline is 5.5%. What works best will vary widely based on company, industry, and overall economic climate. So, it's important to do some math and figure out the right choice for your company and situation.

Designing a 401(k) match: Key considerations

From vesting schedules to encouraging employee participation, there are several factors that go into implementing a 401(k) match. Here's what to keep top of mind:

Legal and regulatory rules

401(k) plans are required to follow various rules and regulations to meet IRS and Department of Labor requirements. One of which is non-discrimination testing, which ensures plans don’t unfairly benefit certain employees.

The  Actual Deferral Percentage (ADP) test and the Actual Contribution Percentage (ACP) test are two of the required tests completed annually for non-safe harbor plans. Employer matching contributions are taken into consideration for the ACP test and can play an important role in whether or not your plan passes testing.

It is also important to note that the IRS sets contribution limits for 401(k) plans every year. The individual contribution limit ($23,000 in 2024) does not include employer contributions. However, the combined contribution limit ($69,000 in 2024) does include employer contributions. It’s important for employers and employees to keep an eye on both contribution limits to ensure they are staying compliant.

401(k) match types

Two of the most common types of 401(k) match options are safe harbor and discretionary matching contributions.

• At a high level, a discretionary match is, as the name implies, made at your discretion. It offers more flexibility, but it is subject to ACP testing.
• A safe harbor match must follow a specific formula. It has more regulations, but as long as the requirements are met they are not subject to ADP/ACP testing.

When deciding which match type is best for you, consider what makes the most sense for your company and team. If flexibility in plan design is important to you, a discretionary match might make more sense. But if you want to lessen compliance risks and flexibility is less of a priority, a safe harbor match could be your best option.

Note: The differences between these two 401(k) match types can get pretty technical, so if you want to dive into the details, be sure to check out our article on the topic.

Vesting schedules

In the context of a 401(k) match, vesting refers to ownership. This means that the employer’s contributions will vest over time before they are fully available to employees. Some employers use a vesting schedule instead of giving employees their full match right away. This means if an employee leaves the company before they are fully vested, they could lose part of the matched funds. This is intended to incentivize employees to stay with the company for the long-term, as well as to reward employees with a long tenure.

Here are some common vesting schedules:

• Graded vesting: Your employees’ vesting gradually increases over a period of time. For example, you select a 4 year vesting period, during which your employees earn 25% vesting for every year of service. So after 1 year they are 25% vested, 2 years 50% vested, 3 years 75% vested, and 4 years 100% vested. For 401(k) plans the longest a graded vesting schedule can be is 6 years.
• Cliff vesting: Your employees become fully vested at a defined point in time. For example, you select a 2 year cliff. Your employees are 0% vested until they hit 2 years of service, then they are 100% vested. For 401(k) plans the longest a cliff vesting schedule can be is 3 years.
• Immediate vesting: Your employees are vested immediately as they receive employer contributions.

As we covered, offering a 401(k) plan and matching your employees' contributions can offer many benefits — from recruiting and retaining employees to potential tax advantages. If you're in the market for a new 401(k), we can help you offer an easy, affordable retirement plan that can be customized for your business goals and your team. Get started today.

Disclosures:

The information provided herein is general in nature and is for informational purposes only. It should not be used as a substitute for specific tax, legal and/or financial advice that considers all relevant facts and circumstances. You are advised to consult a qualified financial adviser or tax professional before relying on the information provided herein.