What is an Employer Matching Program?
In an employer matching program, when you save some of your paycheck by putting money into your 401(k), your company does as well. Your employer will match some money into your 401(k) account as a percentage of the contribution you make. Yes, it’s free money! Typically, you only receive a contribution into your 401(k) plan if you make a contribution yourself. If you fail to save a dollar, your company match goes away too.
How Does It Work?
Let’s take a look at a matching program example whose policy is 50% match up to the first 3%. If you have such a plan, your employer will place 50 cents into your retirement plan for every dollar you put in. There is a limit of 3% of your gross salary that the employer will match each year. If you make $60,000 a year, you would get $900 ($60,000*3%*50%) from your employer simply by putting $1,800 ($60,000*3%) of your salary into your 401(k) account. In this case, not only do you have an extra 50% gain, but you also get the employee contributions tax free until money is withdrawn in retirement.
Rules and Regulations on Employer Matching Program
For tax-year 2015, the maximum amount you can invest in your 401(k) is $18,000. However, if you are 50 or older, you can contribute an additional catch-up contribution amount up to $6,000 for a total maximum 2015 401(k) contribution limit of $24,000.
The 401(k) maximum compensation limit is $265,000 for 2015. That does not mean that there is a 401(k) earnings maximum of $265,000; it means that income above $265,000 does not count for 401(k) purposes.
In addition, contributions made to retirement accounts may never exceed 100% of compensation. This prevents employees from earning a small taxable salary and collecting a huge tax-deferred employer contribution to their 401(k) or other retirement plan.
Dealing With Matching Contribution Cuts
As the 2008 recession took its toll, about a quarter of all businesses pared costs by reducing or suspending their 401(k) matching programs in 2009. Although many brought back their 401(k) matching programs, most did not return to their former shapes. Companies that once matched dollar for dollar up to 6% of gross pay may now match up to a lower cap (e.g., 3%), or contribute less for each dollar an employee contributes (e.g., 50 cents on the dollar). What you can do about it?
- Don’t Abandon Your Plan: With or without the employer contribution, a 401(k) plan still represents a valuable way to invest for retirement. In addition to reducing your taxable income, a 401(k) plan lets you take advantage of tax-deferred earnings and compounding. Over time, this can make a substantial difference in the value of your account compared to taxable alternatives. Plus, the payroll deduction aspect of an employer-sponsored plan makes contributing automatic and regular, a good discipline for investors.
- Increase Your Contribution Rate: If you're not making the maximum contribution to your 401(k) plan, try to increase your contribution rate. You may even find that you can invest enough to make up for the full amount of the lost employer match — although with less take-home pay. For more details on this, read Rules and Regulations on 401(k) Contributions.
- Open an IRA: If you’re already making the maximum contribution to your 401(k) plan, consider diversifying your tax-advantaged retirement savings with an IRA. With a traditional IRA, some or all of your annual contributions may be tax-deductible, depending on your income level and whether or not you contribute to an employer-sponsored retirement plan. Withdrawals from a traditional IRA are taxable as ordinary income in retirement. Your financial advisor can help you determine which type of IRA is most appropriate for you and how much you should contribute.
Rather than making additional contributions to your retirement goal, you may also want to save money for your emergency fund or build a diversified portfolio which are both essential in today’s finance climate.