How Does a 401k Match Work

One of the most common questions we get on the topic of 401k’s is “how does a 401k match work?” So, let’s break it down, shall we?

If you’ve got a job that offers you a 401k plan, you probably already know the basics.

A 401k is a retirement account provided by your company that you can contribute to and your employer matches your contributions. 

That means free money, right? Hell yeah!

It’s true, the contributions your employer makes is “bonus” cash that you don’t have to do anything for (if we don’t count that “working full time” thing).

Additionally, the money you put into your 401k account reduces your taxable income which typically means less taxable income. (Unless you have a bomb ass employer who offers a Roth 401k. In which case, you. are. lucky.)

If you’re foggy on the specifics of what exactly a 401k is and what your other retirement account options are, we’ve already done that research for you, which you can read about here.

Today, we’re talking specifically about the matching (or “free money”) component of the 401k. So, how does a 401k match work? Girl, we got you.

Understanding Your 401k Match

The specifics of each 401k plan really depends on your company. Your employer can provide a very generous match (hooray) or choose not to match your contributions at all (rude). 

Whatever the amount of the matching contribution is, it basically adds free money to your retirement savings, so if the option is there, you might as well go for it.

The Employee Retirement Income Security Act (ERISA) dictates the grittier rules about required contribution limits and withdrawal regulations, but other than that… it’s basically totally up to your company.

Good or bad, depending on how much you like and trust your company, I guess!

You’ll need to refer to the terms of your specific plan to understand what kind of match your employer is making. So, you’ll probably want to hit up Karen in HR on Monday.

How Does a 401k Match Work?

Usually, your employer will match your contributions based on a formula revolving around your total income.

They might match 100% of your contributions up to a certain percentage of your total income or match a percentage of contributions up to the limit.

Basically, it’s a lot of math.

In scenario #1, your employer offers a 100% match up to 3% of your annual income. If you earn $60,000, the maximum amount your employer would contribute each year is $1,800. That means you have to also contribute $1,800 in order to get the full amount of free money provided by your employer. 

In scenario #2, your employer might only choose to match 50% of your contributions up to 6% of your salary. If you’re still earning $60,000, 6% of your salary is $3,600 and therefore that amount is eligible for matching. If your employer only matches 50%, however, that means you’re still only going to get $1,800 in bonus money from them. You have to contribute twice as much to get your full benefit.

Another option is that your employer might match only a certain percentage of your contribution — not dollar for dollar. So, if they’re willing to match 25% of your contribution, you get a “bonus” 25 cents for every dollar you put in your retirement account. 

All in all, there are very few scenarios where your employer is going to match 100% of your contributions every time you contribute forever and ever.

There’s always going to be a limit of some kind.

I know. Big bummer. 

So, the best way to take advantage of this benefit is to make sure you’re contributing enough of your own money to your 401k to get the full amount your employer is willing to match. 

I usually recommend contributing just enough to your employer’s plan to get the 100% match, and then contributing whatever else you can to a Roth IRA that’s not controlled by your employer.

You have lots more investment options and pay way less fees that way. AND you don’t have to leave your job to start taking benefits.

Again, get with Karen in HR on the specifics of your plan to understand how much you should contribute to maximize your benefits. 

Rules and Regulations

No matter whether it’s your own money or your bonus money from your employer’s matching contributions, you’re still not allowed to touch ANY of it in your 401k until the very weird and specific age of 59 ½ (or sometimes 55, depending on your plan). 

If you withdraw funds before the right age, you’re going to pay an additional 10% in taxes in addition to the standard tax rate you pay on the withdrawal.

Though your retirement money is contributed pre-tax, you pay taxes on it when you make withdrawals. Cause there’s just no way to avoid taxes forever.

In terms of other rules, you’ll pay a 6% penalty on any amount contributed to your 401k that exceeds the annual contribution limit.

Wait… so you can get penalized for saving too much? For being too smart and prepared? Seems super fake, but, unfortunately, it’s not. You’ll keep getting hit with that penalty until you withdraw the excess amount — so if you’ve over-contributed, get that money outta there ASAP! 

The good news is, the 401k match allows you to exceed the annual 401(k) maximum contribution limits that the IRS inflicts upon us, so that’s another benefit.

Making Sense of Any of This

As with most things, it’s a little complicated. The bottom line is that a 401k match is “free” money (as much as anything can be “free”) so, for most people, it’s a no-brainer to take advantage of it.

Every situation is different, though, so if you’re still not sure, chatting with both your employer and a trusted financial coach can help you make sense of how to best maximize the profitability of your specific 401k plan. 

How Does a 401k Match Work FAQs