What is a 401(k) retirement savings plan?
A 401(k) is a retirement savings plan some employers offer their team as a financial benefit for working at the company. The U.S. government established the 401(k) to incentivize workers to save for their retirement.
Employees volunteer to have a certain amount deducted from their paychecks each pay period to go toward their 401(k) savings accounts. While employees usually choose how much they’d like to deduct from their paycheck, they often have a limit on how much they’re allowed to contribute.
Employers can offer one of two plans: a traditional 401(k) plan or a Roth 401(k) plan. For traditional plans, 401(k) withdrawals are taxed at the employee’s current income tax rate. Roth 401(k) withdrawals aren’t taxable if the 401(k) account is five years old or older and the employee is over 59 years old. There are specific regulations to follow regarding how much and how often an employee can withdraw these funds for their 401(k).
Many employers use 401(k)s as an employee benefit for working at the company and as an incentive to keep long-term employees. Some employers require employees to work at a company for a certain amount of time before they can start depositing their paycheck money toward a 401(k).
Employees can choose the specific types of investments from a selection their employer offers. Some of these investment types may include stock and bond mutual funds, target-date funds, guaranteed investment contracts (GIC) or the employer’s company stock.
The most common 401(k) matching contribution is an employer contribution of 50 cents for each dollar an employee contributes, up to 6% of the employee’s pay. This is typically considered a generous matching contribution since the average matching contribution is 4.7% of an employee’s salary.
How does employer match count toward 401(k) limits?
Some employers offer a 401(k) employer matching plan, which means they match the amount of pay an employee contributes toward their 401(k). The amount an employer matches can vary, depending on the company and IRS limits. Some employers match a portion of the employee’s contribution, while others match the full amount.
You can make the same contribution for all employees, or it can vary according to much each employee makes and change annually based on their earnings. For example, if an employee receives a raise at the end of the year, their employer may also increase their match amount. The most popular matching plan employers use is matching up to 6% of their employees’ annual income.
Maximum 401(k) company match limits
The employee and employer match limits for 401(k)s fluctuate each year to account for inflation. Since inflation is projected to rise, the 401(k) max contribution is increasing as well.
According to the IRS, the employee contribution amount 401(k) limits per year include:
- 2018: $18,500
- 2019: $19,000
- 2020: $19,500
- 2021: $19,500
- 2022: $20,500
The contribution amount employers decide to match often varies depending on the company’s overall budget. Many people wonder if employer matching counts towards their 401(k) limit, and the answer is yes and no. The 401(k) limit applies to the employee’s sole contributions, but there is also a limit on the combined employee and employer contributions.
The combined limit per year that employees and employers can contribute is:
- 2018: $55,000
- 2019: $56,000
- 2020: $57,000
- 2021: $58,000
- 2022: $61,000
Therefore, in 2022, an employee can contribute up to $20,500 toward their 401(k). The employer can match the employee contribution, as long as it doesn’t exceed the separate $61,000 employer-employee matching limit.
Since matching $20,500 in full would only total $41,000, most employees don’t have to worry about this dilemma. This problem typically arises for individuals who are contributing to more than one employer-matched 401(k) plan or have switched or are switching to a new employer within the year. Employers should continue to communicate limits with employees each year to avoid misunderstandings.
If you have employees who are aged 50 or older, they may be eligible for additional contributions to their 401(k) accounts, also known as catch-up contributions. Catch-up contributions remained the same in both 2021 and 2022.
The 401(k) limits for these additional contributions per year are:
- 2018: $6,000
- 2019: $6,000
- 2020: $6,500
- 2021: $6,500
- 2022: $6,500
If you choose to set up a 401(k) plan where employer matching is based on employee compensation, there are annual limits set in place. For example, if you matched 5% percent of contributions in 2022 and an employee made $325,000 that year, you could only match up to 5% of $305,000, for a total of $15,250.
The 401(k) limits for employer matching based on compensation per year are:
- 2018: $275,000
- 2019: $280,000
- 2020: $285,000
- 2021: $290,000
- 2022: $305,000
The key employees’ compensation threshold increased from 2021 to 2022, from $185,000 to $200,000. Known as the nondiscrimination testing threshold, these limits apply to specific individuals within a company to ensure they remain within specific 401(k) contribution limits.
This regulation helps ensure that company owners and highly compensated individuals don’t overly benefit from 401(k) employee-matched retirement plans. The first category of employees that nondiscrimination testing applies to is key employees.
Key employees are defined as any employee who:
- Owns 5% or more of the company
- Owns more than 1% of the company and makes more than $150,000
- Is compensated $200,000 or higher as of 2022
The 401(k) limits for matching based on key employees’ compensation threshold for nondiscrimination testing per year are:
- 2018: $175,000
- 2019: $180,000
- 2020: $185,000
- 2021: $185,000
- 2022: $200,000
The other type of nondiscrimination testing applies to highly compensated employees (HCE). An HCE is defined as someone who:
- Owned a 5% or more interest in the company in the current year or the year prior
- Earned compensation of $135,000 or higher
The limit for HCEs increased from $130,000 to $135,000 from 2021 to 2022. The 401(k) limits for matching based on the highly compensated employees’ compensation threshold for nondiscrimination testing per year are:
- 2018: $120,000
- 2019: $125,000
- 2020: $130,000
- 2021: $130,000
- 2022: $135,000
Although 401(k) contribution limits have not changed significantly in the past year, employers should still convey the limitations to their employees.
FAQs about 401(k) employer match and contributions
The following questions are commonly asked by employers and employees when considering a 401(k) employer-matched retirement plan.
Can employees enroll in a 401(k) employer match plan as soon as they are hired?
Employers are able to define their own specifications regarding when employees are eligible for 401(k) enrollment. Some companies choose to allow for registration immediately, while others require a certain amount of time to pass, such as the probation period, six months of employment and so on. Employers should make these regulations clear during the hiring process, so employees aren’t surprised if they need to wait.
What are the tax benefits to the employer for offering a 401(k) matching plan?
Employers can use the contributions to employee 401(k) accounts as tax deductions on their federal corporate income tax returns. These contributions may also be exempt from state and payroll taxes. As a result, the employer keeps their employees happy, sees reduced turnover and benefits financially with tax deductions.
Why do 401(k) limits change some years and remain unchanged in others?
The 401(k) contribution limits are adjusted annually in accordance with changes in inflation. The effects of inflation are measured by the consumer price index for urban wage earners and clerical workers. If inflation increases significantly, 401(k) matching limits are increased by increments of $500 or $1,000. However, if the increase in inflation isn’t significant enough, the limits remain unchanged.