Saving money for retirement is something that may stress a lot of people out. You may be wondering how much money you need to save. Or, you may be asking yourself how long will the money need to last? Some things to consider include your health, possible medical bills, as well as your normal expenses. One retirement focused savings tool available to many workers is a 401(k). Something that comes with a 401(k) is a 401(k) match. You may have heard of the term but are still wondering what is a 401(k) match? Well we will give you all the information you need to know so you can make the most out of saving for retirement.
What is a 401(k)?
Before we answer the question of what is a 401(k) match, lets review the basics of a 401(k). A 401(k) is an employer sponsored, defined contribution retirement savings plan. The name comes from the fact that this type of retirement account’s definition is in subsection 401(k) of the Internal Revenue code. Employer sponsored means that you employer manages the process. Defined contribution means that you/your employer make contributions to it. This is different than a defined benefit retirement plan.
When you start a new job, and if your employer offers this benefit, you will get the chance to set one up. It is a very straightforward process and is a great way to start investing. You will get to choose your investments and how much of your annual salary you will want to contribute. In most cases you select a percentage, for instance 5% or 10%.
What type of investments can you hold in your 401(k)?
Your investment options are usually limited t a preselected list that the retirement plan sponsor and your employer pick out. The retirement plan sponsor is a financial institutions that works with your employer and manages all the accounts. They also do all of the administrative tasks like assisting with contributions, distributions, rebalances, fees, and more.
Usually the investments you can pick in a 401(k) are different types of mutual funds. They can focus on capital growth, income, or track the progress of different indexes like the S&P or the Dow Jones Industrial Average. Many plans also offer target date funds which are mutual funds that automatically change your investments based on your age and your expected retirement date.
For instance, the Vanguard Target Retirement 2060 Fund, VTTSX, is a diversified portfolio within a single fund that adjusts its underlying asset mix over time. The fund provides diversification and incrementally decreases exposure to stocks and increases exposure to bonds as each fund’s target retirement date approaches. In this case, the target retirement date or year is 2060.
Besides being a great way to invest, a 401(k) comes with many benefits. The first one being that contributions (money you deposit) are tax-deferred. This means that you don’t have to pay income taxes on your contributions. You also do not have to pay tax on the interest, income, and capital appreciation that occurs within your account.
Just because your contributions are tax free, doesn’t mean you won’t pay any taxes. You will have to pay taxes once you hit retirement age and start making distributions.
This type of retirement account can help you achieve your savings goals. You should be aware that there is a limit to the amount you can contribute. Workers who are younger than 50 can contribute a maximum of $20,500 to a 401(k). This is for 2022, and may change in the future due to inflation or other factors.
If you are 50 and older, you can contribute an extra $6,500 a year in “catch-up” contributions. This means if you are of this age you can contribute a total of $27,000 a year towards your 401(k).
What is a 401(k) match?
Now that we have laid out the foundation of what exactly a 401(k) is, we can discuss the details of a 401(k) match. A 401(k) match is where your employer contributes a certain amount of money towards your 401(k). It is basically free money. Employer contributions to your 401(k) in the form of a 401(k) match does not count towards your personal contributions limits.
Not all employers offer a 401(k) match. If you are in the market for a new job, you may want to ask them this before accepting any offers.
There are a couple ways an employer can contribute to an employees 401(k). The first one is the most popular and this is when they match up to a certain percentage of your annual salary. For instance, if you are contributing 5% to your 401(k), they may match the first 4%. This is why you should always contribute at least up to the amount your employer will match. If you are only contributing 3%, and your employer will match up to 4%, you are leaving free money on the table.
In some cases, an employer may only match a percentage of your match. An example of this is when an employer matches 87.5% of your contributions up to 5% of your total salary. It should be known that some employers put limits on the amount they will match up to a certain dollar amount. This limits their matching liability for those employees making the big bucks.
Many times, an employer may change the percentage of what they are willing to match. The percentage that they match may relate to company wide revenue or profit goals. If a company hits 85% of their specified goal, they may only contribute 3%. If they meet the goal they may match 4%, and if they beat the goal they may match up to 6%.
Do you qualify for a 401(k) match?
You should also be aware that not every employee qualifies for a 401(k) match. You may need to be a full time employee, and you may have to work at the company for a set number of months or even years before you get the match. If you start a new job later in the year, chances are you won’t get the match.
Someone in your human resources department should be able to answer any questions you have about your 401(k), an employer 401(k) match, and if you qualify.
When do you get the 401(k) match?
The timing of when you get your 401(k) match can also depend on your employer. It is common for employers to make their matching contributions at the beginning of each year. Some employers may even pay out your match every paycheck. If your employer makes contributions every paycheck, this may be beneficial. This is because you will have more money invested sooner which can be advantageous. However, there is the chance that if your employer makes a annual matching deposit the timing may be better due to market movements.
Either way, your employer makes the match by just depositing the funds in your 401(k) account. You don’t need to do anything – they do it automatically.
What is a vesting schedule?
Just because you have a 401(k) with your employer and they make matching contributions doesn’t mean that money is yours right away. A vesting schedule determines the percentage of the match that is yours and can be based on the number of years of your employment with the company. If you terminate your employment after just 1 year with the company after you get your match, you may forfeit a percentage of it.
This is common. An example of this is that maybe for the first 3 years of employment with your company, you are only 75% vested in your 401(k) match. This means that if you leave your current employer within 3 years of working there, you only get to keep 75% of the match they make. After 3 years of employment, you could then be fully vested.
Not all employers have vesting schedules – you may be fully vested right after starting. Once you are fully vested, you can leave your job and still have 100% of all 401k. Vesting schedules only affect the matched contributions. You own all of the dollars that you contribute yourself.
What is a 401(k) Match – Summary
A 401(k) is an employer sponsored retirement plan that has tax benefits. This type of retirement savings account can help you plan for your retirement and allow you to live the life you want after you stop working.
There is a lot to know about a 401(k), as well as a 401(k) match. For instance, make sure you know if you qualify for a 401(k) with your employer. If not, figure out how you can. You should also familiarize yourself with the types of investments you can hold in your 401(k), if you are eligible for a 401(k) match, as well as when your employer makes these contributions. Lastly, be sure you know everything there is about your employer’s 401(k) vesting schedule. You don’t want any surprises if you terminate your employment.
Hopefully this article cleared up the question of what is a 401(k) match. If you have anything further, someone from your human resources department should be able to help!