Smart 401(k) Investing—Retirement Savings Overview
How Matching Works
Your employer may "match" some or all of your 401(k) contribution. Matching contributions are funds your employer adds to your 401(k) account over and above the amount you defer from your pay. You don't owe income tax on matching contributions at the time your company makes them, they don't count against your contribution limit, and they compound tax deferred. IRS rules require that all matched funds, including matching based on Roth-directed contributions, reside in a traditional 401(k) account. Matching isn’t required, but many employers adopt it to attract employees, encourage plan participation or benefit from the tax deduction it provides.
Your employer determines how the match is calculated and whether to contribute cash or shares of company stock. One approach is to match 50 percent of what you contribute up to a percentage of your earnings—usually 5 percent or 6 percent. Another approach is to match your contributions dollar for dollar up to a percentage of your earnings—again, usually 5 percent or 6 percent.
Here’s an example of how one method might work:
You qualify for matching by participating in the plan. In fact, one of the most persuasive reasons for making your own contribution is that you’ll be eligible for the additional amount. And knowing that your contributions will be matched up to a certain percentage may encourage you to contribute at least enough to qualify for the maximum.
Another way your employer may add money to your 401(k) account is as part of a profit-sharing plan. In these plans, your employer shares a portion of the company’s profits with each employee any year that profits are made.
If you leave your job to perform military service, and meet eligibility requirements, the Uniform Services Employment and Reemployment Rights Act (USERRA) requires your employer to continue to contribute to your 401(k) or pension plan. 401(k) plan participants have up to five years to make up missed contributions—and employers must also make up any matching contributions within five years. In addition, you may be eligible to withdraw from your account without owing a 10 percent penalty on top of the taxes you may owe, thanks to the HEART Act of 2008. If you take such a withdrawal, you have two years after you leave active duty to put the money back into your account.
Making the Most of a Match
If your employer matches 50 percent of 6 percent of your pay, and you’re contributing 5 percent of yours, you might want to spring for the added 1 percent. If you’re earning $75,000, that would mean $1,125 more in your account—$750 from you and $375 from your employer.
You may also want to check whether your employer calculates matching based on your total annual contribution or the contribution each pay period. If it’s by pay period, there may also be a cap on the amount an employer will contribute in any single period. This means you could end up with more matching if you spread out your contributions over the entire year.
Finally, if you know you’ll be changing jobs before the end of the year, and will have to wait to enroll in your new plan, you may want to increase your contribution rate to put away the maximum for the year—or as much as you can afford—before you move on.
It’s a good idea to check with the person or office responsible for handling your employer’s 401(k) before you make a major decision. You probably won’t be the first person to ask a question, and there may be some helpful answers. For more information, see FINRA’s Investor Alert, Why Leave Money on the Table—Make the Most of Your Employer’s 401(k) Match.
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