401(k) Basics: Employer Matches, Vesting, and the Money People Leave Behind
A 401(k) match is part of your pay, but only if you contribute enough to get it and stay long enough to keep it. Here is how matching formulas and vesting schedules work, with examples.
A 401(k) is an employer-sponsored retirement plan that lets you contribute from your paycheck, often with an employer match. The match is one of the most valuable benefits many workers have, and also one of the most commonly missed. Two details decide how much of it you actually get: the matching formula and the vesting schedule.
The short version
- You choose a contribution percentage; contributions can be pre-tax (traditional) or, if offered, Roth.
- Many employers match part of what you contribute, up to a limit. Contributing less than the matched amount leaves money on the table.
- Your own contributions are always 100% yours. Employer contributions may be subject to a vesting schedule.
- Annual contribution limits are set by law and adjusted periodically; see the IRS for current figures.
How matching formulas work
A common formula: 100% of the first 3% of pay, plus 50% of the next 2%.
For a hypothetical $80,000 salary:
| You contribute | Employer match | Total going in |
|---|---|---|
| 0% | $0 | $0 |
| 1% ($800) | $800 | $1,600 |
| 2% ($1,600) | $1,600 | $3,200 |
| 3% ($2,400) | $2,400 | $4,800 |
| 4% ($3,200) | $2,800 | $6,000 |
| 5% ($4,000) | $3,200 | $7,200 |
| 6% ($4,800) | $3,200 | $8,000 |
Show the numbers behind this chart
| Your contribution (% of $80,000 salary) | Employer match |
|---|---|
| 0% | $0 |
| 1% | $800 |
| 2% | $1,600 |
| 3% | $2,400 |
| 4% | $2,800 |
| 5% | $3,200 |
| 6% | $3,200 |
In this example, the match maxes out at a 5% contribution. Contributing 2% instead of 5% gives up $1,600 a year in employer money, every year.
Other common formulas include 50% of the first 6%, dollar-for-dollar up to a percentage, or profit-sharing contributions not tied to what you contribute.
Watch the timing
Some plans calculate the match per paycheck. If you contribute heavily early in the year and hit the annual contribution limit before December, you could miss match on later paychecks unless the plan has a true-up provision. Ask the plan administrator.
Vesting: when the match becomes yours
Your own contributions are always 100% vested. Employer contributions may vest over time:
| Type | How it works |
|---|---|
| Immediate | Employer money is yours right away |
| Cliff vesting | 0% until a set number of years, then 100% (for example, after 3 years) |
| Graded vesting | Increasing percentage each year (for example, 20% after year 2, rising to 100% after year 6) |
A hypothetical employee has $12,000 of employer contributions and leaves after three years:
If you're considering leaving a job, check where you are on the vesting schedule. A few months can matter. Vesting rules are described in the plan's summary plan description.
Traditional vs. Roth contributions
Many plans offer both. Traditional contributions reduce taxable income now and are taxed when withdrawn. Roth contributions are taxed now and can be withdrawn tax-free in retirement if requirements are met. See traditional vs. Roth.
Investment choices and fees
Plans offer a menu of funds, often including target-date funds; see target-date funds. Check expense ratios and plan fees in the annual fee disclosure; see what a 1% fee really costs.
When you leave a job
Options usually include leaving the money in the plan, rolling it to a new employer's plan, rolling it to an IRA, or cashing out. Cashing out typically triggers income tax and possibly a 10% additional tax if you're under 59½; see early withdrawal penalties and direct vs. indirect rollovers.
Loans and hardship withdrawals
Many plans allow loans or hardship withdrawals. Both have costs and risks; see 401(k) loans.
A five-minute check
- Find your plan's matching formula.
- Make sure your contribution rate captures the full match.
- Check your vesting schedule and years of service.
- Look at your investment choices and their expense ratios.
- Confirm your beneficiary designations.
The takeaway
The match is part of your compensation. Contribute at least enough to get all of it, understand when it vests, and check fees and investments. Those few decisions often matter more than which fund you pick.
Sources
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