How 401(k) Matching Works

Employer matching of your 401(k) contributions means that your employer contributes a certain amount to your retirement savings plan based on the amount of your annual contribution.

Depending on the terms of your employer's 401(k) plan, your contributions to your retirement savings may be matched by employer contributions in several ways. Typically, employers match a percentage of employee contributions up to a specific portion of the total salary. Occasionally, employers may elect to match employee contributions up to a certain dollar amount, regardless of employee compensation.

Matching Contributions: How Much and When

The specific terms of 401(k) plans vary widely. Other than the necessity to adhere to certain required contribution limits and withdrawal regulations dictated by the Employee Retirement Income Security Act (ERISA), the sponsoring employer determines the specific terms of each 401(k) plan.

Your employer may elect to use a very generous matching formula or choose not to match employee contributions at all. Some 401(k) plans offer far more generous matches than others. Whatever the match is, it amounts to free money added to your retirement savings, so it is best to take advantage of it if offered.

Refer to the terms of your plan to verify if and when your employer makes matching contributions. Not all employer contributions to employee 401(k) plans are the result of matching. Employers may elect to make regular deferrals to employee plans regardless of employee contributions, though this is not particularly common.

Employer Matching Contribution Formulas

Most often, employers match employee contributions up to a percentage of annual income. This limit may be imposed in one of a few different ways. Your employer may elect to match 100% of your contributions up to a percentage of your total compensation or to match a percentage of contributions up to the limit. Though the total limit on employer contributions remains the same, the latter scenario requires you to contribute more to your plan to receive the maximum possible match.

Some employers may match up to a certain dollar amount, limiting their liability to highly compensated employees regardless of income. For example, an employer may elect to match only the first $5,000 of your employee contributions.

"Your employer could match 100% or even a dollar amount based upon some formula, but this can get expensive and normally owners want their employees to take some ownership of their retirement while still providing an incentive," says Dan Stewart, CFA®, president, Revere Asset Management Inc., in Dallas, TX.

How Matching Works

Assume your employer offers a 100% match on all your contributions each year, up to a maximum of 3% of your annual income. If you earn $60,000, the maximum amount your employer would contribute each year is $1,800. To maximize this benefit, you must also contribute $1,800. If you contribute more than 3% of your salary, the additional contributions are unmatched.

A partial matching scheme with an upper limit is more common. Assume that your employer matches 50% of your contributions, equal to up to 6% of your annual salary. If you earn $60,000, your contributions equal to 6% of your salary ($3,600) are eligible for matching. However, your employer only matches 50%, meaning the total matching benefit is still capped at $1,800. Under this formula, you must contribute twice as much to your retirement to reap the full benefit of employer matching.

If your employer matches a certain dollar amount, as in the first example, you must contribute that amount to maximize benefits, regardless of what percentage of your annual income it may represent.

Contribution Limits

Employee and Employer Combined

All deferrals are subject to an annual contribution limit dictated by the Internal Revenue Service (IRS) regardless of whether contributions to your 401(k) come from you and/or from employer matching. The total contribution amount allowed for all 401(k) accounts held by the same employee (regardless of current employment status) is $66,000 in 2023 or 100% of compensation, whichever is less. That's $5,000 higher than the 2022 limit of $61,000.

Employee Alone

Elective salary deferrals made by employees alone are limited to $22,500 in the tax year 2023, up from $20,500 in the tax year 2022. A saver can contribute up to the annual salary deferral limit to their 401(k) each year, and an employer can match or contribute up to the combined IRS annual limit referred to above. The sum your employer matches does not count toward your annual salary deferral limit. 

Keep in mind that these figures can be updated each year by the IRS to keep pace with inflation. The announcement of the following year's various limits is usually made in October or November.

The IRS also allows those who are age 50 and over to make catch-up contributions in addition to their normal contribution. These are designed to encourage employees nearing retirement to bulk up their savings. The catch-up contribution amount is $7,500 in 2023, up from $6,500 in 2022.

Therefore, for these individuals, The individual total deferral amount for these individuals is $30,000 ($22,500 + $7,500). The combined employer/employee limit is $73,500 ($66,000 + $7,500).

401(k) Vesting Schedules

In addition to reviewing your 401(k) plan's matching requirements, educate yourself about your plan's vesting schedule. A vesting schedule dictates the degree of ownership you have in employer contributions based on the number of years of your employment.

Even if your employer has a very generous matching scheme, you may forfeit some or all of those contributions if your employment is terminated—either voluntarily or involuntarily—before a certain number of years has elapsed.

Any contributions you make to your 401(k) account yourself are 100% vested at all times and cannot be forfeited.

"A typical schedule gives an employee a percentage of ownership that steadily increases in lock-step with the employee's tenure. According to the Bureau of Labor Statistics, the average number of years to be fully vested is five," according to Mark Hebner, founder and president of Index Fund Advisors Inc., in Irvine, Calif., and author of "The 12-Step Recovery Program for Active Investors."

The Bottom Line

One of the great advantages to those Americans saving for retirement through their workplace 401(k) accounts is the added money that they can accumulate by way of employer matching. Employers may or may not offer the benefit of matching. But if they do, try your best to contribute all that's needed to get as much of these additional funds as you can annually. By doing so, you can boost your savings potential for years to come.