Choosing an appropriate 401(k) matching contribution depends upon various considerations. Employer matches are not required by law. Employers must first determine whether they should provide a matching contribution on employee deferral contributions and, if so, the amount. Many experts advise beginning with no match or a low one since a 401(k) matching contribution can easily be increased but may be difficult to reduce. However, since a matching contribution can increase employee participation and 401(k) deferrals, motivate employees to save for retirement and help reduce employer contributions that may be needed to pass the "nondiscrimination tests," adopting a matching contribution is frequently advantageous when establishing the 401(k) plan.
Variations among 401(k) matching contributions are likely. A common employer matching formula is 50% of 401(k) employee deferral contributions, based on a maximum employee deferral rate of 6% of compensation. The following should always be considered when determining the match:
1. The anticipated effect of a match with regard to attracting and retaining valuable employees. Employee demographics are a factor in making this determination.
2. The expected cost of the match. If a vesting schedule is selected, a portion of the match may be forfeited at a future date which would reduce its effective cost.
3. The use of a "discretionary" match. Although the employer need not make matching contributions under such circumstances, using a discretionary match will obviously be less attractive to employees than a non-discretionary one.
4. The effect of the match on passing the 401(k) nondiscrimination tests. It is possible that a matching contribution may result in greater savings for the employer than the cost of the match itself, since it may reduce or eliminate any contributions that may be needed to satisfy the nondiscrimination requirements. A safe-harbor 401(k) match is often used for this purpose.
5. The frequency of the 401(k) match is also important; the more frequently the employer matches 401(k) employee deferrals, the greater will be expected employee participation in the 401(k) plan.
6. The matching contribution offered by competitors.
7. Restricting the match to certain participants. Employer matching contributions may be restricted and not allocated to participants who complete fewer than 1000 "hours of service" in a year or are no longer employed by the company at the end of the year. Since this may result in the plan's failing to satisfy the coverage requirements regarding "non-highly compensated" employees, care should be used in making such an decision.
It is important to communicate the employer match and the influence it can have on a participant's retirement income for it to be fully appreciated and increase employee participation.