If you work for a company that provides a 401(k) match, consider yourself lucky. In this age of the COVID-19 and company cut backs, the company match is one of the first things to go. Already a number of major universities and corporations in the Boston area have already eliminated their match.
The company match is designed to encourage employees to participate in the plan. Employers need employees—especially the rank and file—to participate so that the plan passes annual compliance testing. This testing is intended to make sure that all employees benefit significantly and not just the owners or highly-compensated employees.
This testing can get pretty dicey if the only contributors are the owners and just a few highly-paid employees. That can cause the plan to fail its annual testing. If that happens, the employer is faced with several unattractive and costly solutions to fix the problem.
Safe Harbor Match
But there is an easier solution, the Safe Harbor Match. This type of match allows the employer to forgo certain tests because they are contributing minimum amounts to your 401(k) plan. Here are two common types:
Voluntary match (most common)
Employer contributes based 100% on the first 3% of pay and 50% of pay on deferrals from 3-5% of pay. If an employee contributes 5% of their pay, they will receive a matching contribution from their employer equal to 4% of their pay.
Example: An employee earns $100,000 per year and contributes 5% to their 401(k): 100,000 x 100% x 3% = 3,000 plus 100,000 x 50% x 2% = 1,000. Total employer contribution = $4,000.
Non-elective contribution (less common)
Employer makes a non-elective (e.g., mandatory) contribution for all eligible non-highly compensated employees equal to at least 3% of pay. Example: An employee earns $100,000 per year. The company contributes 3% to their 401(k) or $3,000. All employees receive this contribution regardless of whether they contribute to the plan or not.
Over time matching (or non-elective contributions) can have a powerful effect on saving for retirement. Consider the following for an employee earning $100,000: Employee contributes $150/week without a match for 20 years with 5% growth = $257,914.
Contribute $150/week with voluntary safe harbor match for 20 years with 5% growth: $390,178.
That’s a difference of $132,264! (Something to think about the next time you are applying for a new job.)
There is no requirement that your employer provide a company match but most do to be competitive with other employers. If your employer is doing well financially, you might want to ask them if they have considered adding an employer match. Just by asking you could nudge your employer to add this important benefit.
I have found that most employees do not understand how their match works or how it is calculated. Given the importance of saving for retirement—and the large difference above—the 401(k) match should not be overlooked.
We talk a lot about Roth IRAs on this blog. But you can also participate in a Roth through your employer 401(k), too. This is great for those that can benefit from a Roth because there are no income limits on Roth 401(k) contributions as there are for Roth IRAs. If your plan does not offer the Roth option, ask your employer. Usually there is a nominal cost to add it to your plan.
If you still have questions about your 401(k), give us a call. We’re here to help.
Lyman H. Jackson
Financial Planning Solutions, LLC (FPS) is a Registered Investment Advisor. FPS provides this blog for informational and educational purposes only. Nothing in this blog should be considered investment, tax, or legal advice. FPS only renders personalized advice to each client after entering into an advisory relationship. Information herein includes opinions and forward-looking statements that may not come to pass. Information is derived from sources believed to be reliable. Information is at a point in time and subject to change without notice. Such information may not be independently verified by FPS. Please see important disclosures link at the bottom of this page.