What is 401(k) matching? How does it work? Why should you use it?

A 401(k) account is one of the most effective ways to save for retirement. Not only do they allow for convenient contributions via automatic payroll deductions, 401(k)s are company-sponsored retirement plans, which means they often come with a matching program.

When your employer matches your 401(k) contributions, you are literally getting free money added to your retirement savings­—and who doesn’t want that?

According to the Bureau of Labor Statistics, about 56% of all U.S. employers currently offer a 401(k) program, and about 51% of those who do also offer some sort of 401(k) matching. That’s millions of employers, maybe yours included. By taking advantage of these matching opportunities, you can significantly increase your retirement savings, without losing more money from your paycheck.

Have you checked if your company offers a 401(k) match? (If not, you should, ASAP.)

Let’s take a look at how 401(k) matching programs work, and answer some of the most common questions you might have.

What is a 401(k) match?

A 401(k) match refers to the contributions your employer makes to your 401(k) on your behalf. It’s called “matching” because your employer will match a certain percentage of your initial contributions. The amount they will match is detailed in the match rate, which we’ll explain in the next section.

Oftentimes, an employer match is referred to as “free money.” Fundamentally, that’s accurate! The only stipulation is that you contribute a certain amount to your 401(k) first.

Generally, you also need to meet a threshold in order to get your match: In other words, you have to contribute a certain amount before they contribute their match portion.

In addition to a 401(k) match, your employer might also offer other matching programs, including IRA matching programs, health savings accounts (HSAs) matching, and more. Each of these programs is usually considered a part of your broader benefits package, which is among the most effective tools employers can use to attract and retain employees and you can use to improve your personal finance picture.

Should I use my employer’s 401(k) match?

Yes!

We can’t emphasize this enough: Not taking advantage of your employer’s match program is one of the biggest mistakes you can make.

Employer matches can help you increase—even double—your retirement savings for free. With the compound interest your 401(k) accrues over time, that can potentially make a difference of hundreds of thousands of dollars down the line.

How do I know if I have a 401(k) match?

The details on the 401(k) program your employer offers, including whether or not they offer a match program, will be included in your benefits package. If you’re not sure if you have one, contact your HR representative or your benefits provider to find out more.

Your benefits package should not only tell you if you have a match, but how your employer’s particular matching program works.

How does 401(k) matching work?

Generally, all 401(k) matches will fall into one of two categories: Static 401(k) match rates and dynamic 401(k) match rates.

First, let’s talk about static match rates.

With a static matching program, your employer will match a certain amount of 401(k) contributions at a fixed rate, meaning that rate will not change over time.

Take this example: You are earning $50,000 per year, and your employer is offering a 100% 401(k) match up to 6% of your income.

The “100%” means this a dollar-for-dollar match. 6% of your $50,000 salary is $3,000. Keep in mind, $3,000 is the maximum, so if you contribute $600, they’ll also contribute $600. However, since your employer is willing to contribute $3,000, it’s in your best interest to get that full match. This means you need to contribute $3,000 to your 401(k) first; then, they’ll contribute the 100% match, and you’ll have $6,000 in your 401(k). Sounds pretty great, right?

Now, let’s talk about dynamic match rates.

A dynamic 401(k) match means the rate at which your employer will match your contributions will change over time. Usually, it means once your contributions have reached a certain percentage of your salary, the match rate changes.

These different rates included within one 401(k) matching policy are often referred to as tiers.

Let’s consider this example of dynamic match rates: You are earning $50,000 every year, and your employer offers a match of 100% up to 4% of your salary, then a 50% for the next 2% of your salary.

In this case, you must first contribute 4% of your salary—$2,000—to get the 100% match. This means your employer would contribute another $2,000, leaving you with $4,000 in your 401(k).

Then, you could continue to contribute to your 401(k) another 2% of your salary—that’s $1,000—which your employer will match at 50%. Now, you can put in $1,000, and your employer will add another $500.

In total, you’ll have $5,500 in your 401(k), and you only had to contribute $3,000 in total.

Even though, in these examples, the static rate left “you” with more money in your 401(k), every match policy is different. Sometimes, dynamic match policies can be incredibly lucrative.

It’s important to remember, too, that you can always contribute more than the amount your employer is willing to match. That choice is up to you, your budget, and your retirement savings plan.

How much can I contribute to my 401(k) in 2022?

Due to the economic impact of the Covid-19 pandemic, the IRS has been consistently raising the 401(k) contribution limit for individuals as an incentive for people to save for retirement, despite tightening budgets in a huge majority of American households. As of 2022, the IRS set the 401(k) contribution limit at $20,500 per year. This is $1,000 more than the 2021 limit.

However, if you are over the age of 50, you’ll actually be allowed to make an additional $6,500 in what are called “catch-up contributions” every year, since retirement age is right around the corner for 50+-year-olds, and you might need to be more aggressive in your savings strategy to reach your financial goals.

These limits change fairly often, so if you are hoping to make large contributions to your 401(k), you’ll want to be sure to stay up to date.

When is the employer match added to my 401(k) account?

Another thing to keep in mind while planning for retirement is a concept called “vesting.”

In retirement planning, vesting is a term used to describe your personal ownership of your retirement savings. Unlike IRAs, which are connected to individuals, 401(k)s and other company-sponsored retirement plans are connected to employers. The amount that has vested in your 401(k) account is the amount that you actually own and will have the right to access if and when you leave your employer.

The contributions you have made to your 401(k) via payroll deductions or otherwise are always yours to claim. (In other words, those vest immediately.) However, when an employer makes contributions to your 401(k) via a matching program, they may vest on a schedule.

A vesting schedule, which should be detailed in your benefits package, defines when you will personally own the amount that your employer has contributed to your 401(k). Oftentimes, vesting schedules have the match money vest periodically: For example, 50% of your employer’s contributions might vest once you’ve worked at the company for one year, and then vest the remaining 10% every quarter afterwards. Or, a vesting schedule might say the match contributions will become “fully vested” after three years of employment.

Does 401(k) matching affect my taxes?

Traditional 401(k) plans are tax-deferred, which means you do not pay income tax on the contributions you make. However, you will have to pay income taxes when you withdraw your money upon retiring. Roth 401(k)s are the opposite: You do pay income tax on your contributions, but you do not have to pay tax when you withdraw.

In the case of a traditional 401(k), if you are making $50,000 and contribute $5,000 of your salary to your 401(k) one year, you will only pay income tax on $45,000. (Of course, taxes are pretty complicated, so there may be exceptions or stipulations.)

Is a 401(k) match worth it?

Without a doubt, yes.

If your employer currently offers a 401(k) matching program, it is almost always in your best interest to take advantage of this program to the greatest extent you can.

This money is essentially sitting on the table for you to claim as long as you contribute to your 401(k) first. Of course, once you do decide to take advantage of these programs, be sure you fully understand all taxes and other responsibilities involved along the way.

You work hard for your company. Make them work just as hard for you and your finances. Take advantage of that match—and do it as soon as you can!