I’ve noticed that a few people have reached The Frugal Couple by searching for more information on how 401(k) matching works, so I figure it’s something of interest.
401(k) matching is something that many employers offer as an extra benefit to their employees. I’ve had two employers who offer matching, and they have done it differently. My last employer matched 60% of the first 6% of my salary that I contributed.
To better explain this, I’ll take the example of someone making $50,000 per year. Let’s say he contributes 6% of his salary ($3,000 per year) to his 401(k). My employer would contribute (sometimes called matching) an additional 60% of $3,000, or $1,800. If the employee contributes $7,000 per year, the employer will only contribute $1,800. If the employee contributes $2,000, the employer will contribute 60% of that, or $1,200.
In order to provide an incentive for its employees to stick around, my employer uses a vesting schedule to dole out the contributions over time. In our case, it’s five years. So after the first year of service, if the employee leaves the company, he gets to keep all of his own contribution ($3,000 in the first example) and 20% of the $1,800 (or $360). After the second year, the employee gets to keep 40% of the $1,800. Each year it increases by 20 percentage points until it reaches 100%. After the fifth year, all employer contributions are fully vested. So you don’t have to wait an additional 5 years for the contributions made in years 4 and 5.
I worked at another employer that matched 100% of the first 3% of contributions. In my casual conversations with people, it seems that most employers that match contributions match between 3% and 5% of the total cash compensation of the employee.
If your employer offers matching of retirement contributions, it makes sense to give serious consideration to invest the full amount that takes advantage of the employer’s contribution limit. Otherwise, you’re giving away free money.