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 could 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.

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 feature provides an opportunity for the employer to contribute to an employee’s retirement account based on how much that employee defers into the plan. Matching contributions are like an additional reward for saving for your retirement.

The popularity of 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 aggregate compensation of all eligible employees). That means employer matching contributions aren’t subject to the same tax treatment as forms of taxable compensation, such as bonuses.¹

Even though matching contributions are tax deductible by the company, they are typically 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. With the passage of SECURE 2.0, employers have the option to allow an employee to treat their matching contribution as a Roth contribution. There are specific conditions an employee must meet and the election is irrevocable. The contribution amount will be included in their taxable income for the year it’s made but the participant will benefit from the funds being tax free when distributed.

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

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 an employer 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 $23,500:

50% x $23,500 = $11,750 (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 $23,500 amounts to an impressive $11,750, the employee won’t receive more than $5,100, or 6% of her salary. Even so, that’s an impressive total of $28,600 safely tucked away. Not too shabby.

This example is for illustrative purposes. It should not be taken as investment, legal, and or tax advice.

Contribution limits

For 2025, employee 401(k) contributions are capped at $23,500 per year (or $31,000 for individuals aged 50 or older). It’s important to note 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 $23,500 limit—which is partly why they’re so lucrative for employees looking to maximize their retirement savings.²

That said, there is a cap on the combined amount that an employee and employer may contribute in a year: for 2025, $70,000 (or $77,500 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 require an employee to make 401(k) deferrals to receive the benefit. Instead, all eligible employees, whether or not they choose to make salary deferrals, receive an allocation of the employer’s profit sharing contributions. Consequently, these sorts of discretionary profit sharing contributions are commonly referred to as "Nonelective Contributions."

Vesting schedules

While employer matching is certainly an attractive feature, employees are rarely entitled to their entire employer contribution account right away. Instead, employer contributions may be subject to a vesting schedule. A "vesting" provision in a plan document requires an employee to accrue a designated percentage of vesting each year 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 accrue more than six years of vesting service to be 100% vested.

There are two types of vesting schedules: graded and cliff. Under the graded approach, employer contribution accounts will gradually vest in increments, with the most common being 20% 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

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

An employee is always 100% vested in the following contributions: elective deferrals, traditional safe harbor contributions, qualified non-elective contributions (QNECs) and qualified matching contributions (QMACs). 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 does not impact the amount of employer match being contributed by the employer. Instead, employees who are not fully vested upon terminating employment will forfeit the unvested 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 Roth elective deferral contributions. That’s false.

That said, there’s an important caveat to consider. While employers can match an employee’s Roth elective deferral contributions, these funds need to be placed in a separate, employer contribution account. While employees are generally not taxed when distributing their Roth account, they will be taxed when distributing their employer matching contribution account.

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

401(k) compliance

While employers aren’t required to offer an employer match feature, there can be substantial benefits to doing so—especially when it comes to compliance and reporting.

A Safe Harbor plan is a type of 401(k) plan that is exempt from most nondiscrimination testing and can be an attractive strategy for small businesses that would typically have problems with plan compliance, or wouldn’t otherwise have the resources to manage it.³

However, a Safe Harbor plan comes with a price — to qualify, the plan must either offer a mandatory employer matching contribution or nonelective contribution. Further, either form of employer contributions must generally vest immediately. An exception is a plan that offers a QACA Safe Harbor feature (see below). This type of safe harbor can elect up to a 2-year graded or cliff vesting schedule, but must follow additional other rules involving auto-enrollment.

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

To maintain Safe Harbor status using a nonelective contribution formula, 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.

When companies offer a 401(k) match, they’re doing more than just capitalizing on an employer tax deduction. Today, employee tenure averages just under four years. Among millennials, those numbers are even lower. By investing in employees’ futures, companies can 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.⁴