/ 401(k)

The Small Business Guide to 401(k) Matching

We all want to find our perfect match—especially one we can retire with.

Between the tax advantages and this year’s higher contribution limits, employees have plenty of incentive to put money aside for retirement. The most persuasive nudge, however, might just be an employer’s promise to pitch in. One industry study found that employer matching contributions weren’t just a motivating factor for 401(k) enrollment, but were actually the leading one overall.

So how does this important incentive work? Below, we’ll cover everything you need to know about 401(k) matching.

401(k) employer matching 101

A 401(k) plan with an employer match promises that the employer will contribute to an employee’s retirement account based on how much that employee defers. Matching contributions are like an additional reward for saving for your retirement. For a perk so generous, employer matching is surprisingly common—three-quarters of small and mid-sized businesses with a retirement plan offer some form of it.

The popularity of 401(k) employer matching contributions shouldn’t come as a surprise given their favorable tax treatment. For starters, matching contributions are 100 percent tax deductible for employers, up to the annual corporate tax deduction limit on all employer contributions (25% of covered payroll). That means employer matching contributions aren’t subject to the same tax treatment as forms of taxable compensation, like bonuses or raises. Even though they are also deductible by the company, matching contributions are not included in the employee’s gross income until distributed, and they escape both the employer and employee portions of FICA (Medicare and Social Security), unemployment, and other payroll taxes. Matching contributions have the added upside of being able to grow tax-deferred over time, which isn’t true of a regular raise or bonus, unless you specifically invest your money in tax-advantaged securities like municipal bonds.

Another reason matching contributions are so popular is that they usually increase the participation rate of the company’s rank-and-file employees, which ordinarily are the least inclined to make 401(k) contributions. A matching contribution is a powerful incentive for them to get in the game and not walk away from “free money.” When these employees contribute more, the plan itself is less likely to fail annual nondiscrimination testing, which helps owners and executives in the long run.

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There are a few different approaches to calculating an employer match. Typically, the formula is a simple one: a percentage of what an employee contributes to their 401(k) account, capped at a percentage of their salary. Survey data shows that nearly half of businesses offering a 401(k) match cap their matching contributions at 6 percent of the employee’s salary.

Overall, the most popular formula is 50 percent of deferrals, up to 6 percent of wages. For example, here’s how the annualized match would be calculated for an individual earning an $85,000 salary who contributed $19,000:

50% x $19,000 = $9,500 (half of what the employee contributed) but...

6% x $85,000 = $5,100 (the maximum amount the employer will match)

Even though 50 percent of $19,000 amounts to an impressive $9,500, the employee here won’t receive more than $5,100, or 6 percent of her salary. Even so, that’s an impressive total of $24,100 safely tucked away. Not too shabby.

Contribution Limits

For 2019, employee 401(k) contributions are capped at $19,000 per year (or $25,000 for individuals aged 50 or older). It’s important to note that this cap applies strictly to what an individual contributes, not what an employer matches. In other words, 401(k) employer matching contributions are NOT applied against the $19,000 limit—which is partly why they’re so lucrative for employees looking to maximize their retirement savings.

That said, there is a cap on the combined amount that an employee and employer may contribute in a year: for 2019, $56,000 (or $62,000 for individuals aged 50 or older). If that number seems surprisingly high, remember that companies have another means of contributing to employee retirement accounts, in addition to matching contributions: profit sharing. Profit sharing contributions don’t even require an employee to make 401(k) deferrals to benefit. Instead, all eligible employees, whether or not they choose to make salary deferrals, receive an allocation an employer’s profit sharing contributions. Consequently, these sorts of discretionary profit sharing contributions are commonly referred to as “Nonelective Contributions.”

Vesting Schedules

While 401(k) matching is certainly attractive, employees are rarely entitled to their entire employer contributions account right away. Instead, employer contributions may be subject to a vesting schedule. A “vesting” provision in a plan document puts employer contributions at risk of forfeiture until an employee has worked for the company for a specific period of time. Current 401(k) law states that any vesting schedule can’t require an employee to accumulate more than six years of service to be 100% vested.

There are two kinds of vesting schedules: graded and cliff. Under the graded approach, employer contribution accounts will gradually vest in increments—say, 20 percent per year of service. With cliff vesting, employer contributions vest all at once, after the employee serves the minimum length of time (not more than 3 years).

Maximum Vesting Schedules (Graded vs. Cliff)

Tenure (years) Graded Vesting Schedule Cliff Vesting Schedule
Less than 2 0% 0%
2 but less than 3 20% 0%
3 but less than 4 40% 100%
4 but less than 5 60% 100%
5 but less than 6 80% 100%
6 or more 100% 100%

An employer may choose a more favorable graded or cliff vesting schedule, but not one that is more stringent than the above.

Remember that an employee is always 100% vested in contributions from their own wages. Vesting is about the right to receive a future distribution of the employer contributions  upon leaving the employer. The percentages associated with a vesting schedule don’t impact the size of the employer match being deposited into the employer contributions account. Instead, employees are not fully vested upon terminating employment, they will forfeit a portion of the employer contributions that have already been deposited to their account at the time they take a distribution.

So what’s the most common vesting schedule? According to the Bureau of Labor Statistics, nearly half of companies with a retirement plan choose a graded schedule spaced out over five years. Other popular choices are to use cliff vesting, or no schedule at all (i.e., employer contributions are treated just like employee deferrals and vest immediately).

Traditional vs. Roth Contributions

Here’s a myth you’ve likely heard: Employers aren’t allowed to match employee after-tax Roth contributions. That’s false.

That said, there’s an important caveat to consider. While employers can match an employee’s 401(k) after-tax Roth contributions, these funds need to be placed in a separate, pre-tax employer contributions account. On the back end, that means needing to administer two accounts for each Roth participant with very different tax treatment. While employees won’t usually owe taxes upon distribution of their Roth accounts, they will upon distribution of their employer contributions accounts.

Bottom line? Employers can match Roth contributions, but those matching contributions (and their investment earnings) are always pre-tax.

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401(k) Compliance

While employers aren’t technically required to offer a match, there are substantial benefits to doing so—especially when it comes to compliance and reporting.

A Safe Harbor plan is a kind of 401(k) plan that is exempt from nondiscrimination testing and is an attractive strategy for small businesses that would typically have problems with plan compliance, or wouldn’t otherwise have the resources to manage it.

But a Safe Harbor plan comes with a price - to qualify, the plan must either offer an employer matching contribution or a nonelective contribution. Further, either form of employer contributions must generally vest immediately. An exception is that QACA Safe Harbor plans (see below) may have a 2-year vesting schedule, but must follow additional other rules involving auto-enrollment.

To maintain Safe Harbor status using matching contributions, opt for one of the approaches below:

  • Basic matching: 100% match on deferrals up to 3% of compensation, plus a 50% match on deferrals between 3% and 5% of compensation.
  • Enhanced matching: Any matching formula at least as generous as the Basic matching formula at each tier, but the employer cannot incentivize a contribution more than 6% of compensation.  A common enhanced matching formula is 100% match up to 4% of compensation.
  • QACA match:  A Qualified Automatic Contribution Arrangement (QACA) is a special type of Safe Harbor plan with a minimum match of 100% of the first 1% of compensation, plus a 50% match on deferrals between 1% and 6% of compensation.

To maintain Safe Harbor status using nonelective contributions, the plan must provide an employer contribution of at least 3% of compensation to all eligible employees, even those that don’t contribute anything themselves.

For examples of each approach, read our full guide to Safe Harbor 401(k) plans. Note that these represent the bare minimum contributions–employers aren’t barred from being more generous.


When companies offer a 401(k) match, they’re doing more than just capitalizing on an employer tax deduction. Today, employee tenure averages just four years. Among millennials, those numbers are even lower. By investing in employees’ futures, companies gain an upper hand in the race to attract and retain talent.

Guideline makes it easy and affordable to offer a 401(k) plan with matching contributions. We’ll work with you to help design a plan with an employer match that encourages employees to save for their retirement—and hopefully stick around, too. Schedule a demo with one of our retirement experts today.

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Nicolle Willson, J.D., CFP®, C(k)P®

Nicolle Willson, J.D., CFP®, C(k)P®

Head of Retirement Consulting at Guideline. JD, UCLA Law. Certified Financial Planner™. Certified 401(k) Professional™. Previously a financial planner with focus on retirement & estate planning.

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