If you are working and have access to a 401(k) plan from your employer, you may have heard references to a “company match” on contributions. What does this mean? It means that your employer is helping you save for retirement by matching the money you contribute, up to a certain amount.
These matching funds can be a very powerful way to save money over time, and it’s important take advantage of a company’s full 401(k) match if you can. Every company has different policies regarding these matching funds, and things can often be confusing for new investors. Here are some key things to know.
1. The match is free money
A 401(k) match is not a bonus based on your job performance. It’s not a payment made in lieu of your salary. It’s truly a contribution from your company to help you save for your retirement, which you can use to invest in a variety of mutual funds and other investments.
There’s only one catch, which is that you need to direct a portion of your own money into the 401(k) plan first. That’s why they call it a match. Some employers will automatically sign you up for the 401(k) plan and set aside a certain percentage of your salary as a contribution each pay period. (Don’t worry — you can always adjust that amount.) If you are unclear on how much you should contribute to your 401(k), try to at least put aside enough to get the maximum company match. If you miss out on the full match, you are missing out on free cash that could add up to tens of thousands of dollars or more over time. (See also: How to Tell if Your 401K Is a Good or a Bad One)
2. Companies match differently
There is no standard or required way for employers to match 401(k) contributions. Some companies are very generous and match every dollar you contribute, no matter how much you put in. Others will match only a very small percentage. Matching contributions can change if a company is doing better or worse financially. When searching for a job, learning about a company’s matching policy can help you decide whether you want to work there. Think of the 401(k) plan as part of a company’s overall benefits package.
A company’s match may also offer some insight into the overall health of the firm. If a company recently stopped matching contributions, that’s a red flag that the company may be in trouble.
3. There is often a “vesting” period
Many employers will begin matching contributions as soon as you begin working there, but you may have to give back those matching funds if you leave the company after a specific time. For example, if you’ve been setting aside 5 percent of your salary into your 401(k) and your company is matching that, you don’t necessarily get to keep the company’s contributions right away. You may have to wait one year, three years, or even longer to keep that money permanently. This is called a vesting period.
About half of employers offer immediate vesting, according to one Vanguard survey. But others have different vesting schedules. Some will allow you to keep a portion of company contributions after a certain amount of time, and increase that total annually until you are fully vested. (Example: 20 percent vested in year one, 40 percent vested in year two, etc.)
Vesting schedules and policies can be confusing and can change, so be sure to read your 401(k) plan documents carefully. And if your company does have a vesting period for its 401(k) match, try to avoid leaving before that time is up, as doing so could result in you forfeiting thousands of dollars plus any future investment gains. (See also: 8 Critical 401(k) Questions You Need to Ask Your Employer)
4. Contribute more, get more
Here’s a brain teaser for you: If Company A makes a dollar-for-dollar match on all employee contributions up to 4 percent, and Company B matches contributions up to 8 percent at 50 cents on the dollar, which company is contributing more?
The answer is that they are both contributing the same amount. The difference, however, is that Company B is using its matching funds to incentivize workers to contribute more of their own money. If you take advantage of Company B’s full match, you will have more money in total because your own contribution will be higher. Contributing more yourself will also save you money because those funds are deducted from your taxable income.
5. Matching money doesn’t count against contribution limits
The IRS places a limit on the amount of money you can contribute to a 401(k) each year. For 2018, that limit will be $18,500. It’s important to note that this limit only applies to money that the individual contributes. Money from the company match does not count against this total. Thus, the total amount of money from all sources going into your 401(k) each year could be much more than the IRS limit. Feel free to contribute as much as you can, take advantage of the full company match, and watch your savings grow. (See also: 6 Ways Meeting the 2018 401(k) Contribution Limits Will Brighten Your Future)
6. Sometimes the match comes as company stock
In some cases, employers will contribute all or part of a 401(k) match in the form of company stock. While free company stock is better than nothing, it’s risky to have it comprise too much of your savings. Your employer already pays your salary, so your financial security is already tied to the company’s success. Past employees of Enron and other failed companies can attest to the risk of having too much of their savings tied up in company stock.
If you receive company stock in your retirement plan, consider adjusting your investment mix so company stock doesn’t comprise more than 5 to 10 percent of your portfolio. (See also: 7 Things You Need to Know About Investing in Company Stock)
7. It doesn’t pay to front load your contributions
Let’s say it’s January and you just got a big pay raise, a bonus, or both. You may be tempted to throw as much money as you can into your 401(k) at that point. If your employer matches based on pay period, you may miss out on matching funds if you max out your contributions early.
So for example: Let’s say you earn $200,000 annually and choose to set aside 30 percent of your income per month in the first few months of the year. And let’s say your company matches all contributions up to 5 percent of your salary per pay period. Under this scenario, you will have maxed out your contributions by April and won’t be able to contribute any more for the rest of the year. Meanwhile, your employer has only contributed up to the maximum company match for those first few months. In this case, your company will have put in about $3,332 when you would have received $10,000 in matching funds if you had spread the contributions out.