Financial Advisor in Raleigh NC: 401k Matching

Many companies offer a 401(k) retirement plan to their employees. Some companies also provide a company match as an extra bonus.

A 401(k) company match is when your employer adds money to your retirement account. The amount added is based on how much you contribute. The employer's contribution is limited to a certain percentage of your income.

Employer Match Does Not Count Toward 401k Limit

When it comes to your 401(k) contributions, there are two aspects to consider: your personal contribution as an employee and any matching contribution from your employer (if applicable). The amount you can contribute as an individual is subject to an annual limit.

For the tax year 2023, this limit has increased to $22,500, representing a $2,000 rise from the 2022 level. The contribution limit includes the amount of money you decide to save from your paycheck. This money is then invested in your 401(k) before any taxes are deducted.

The good news is that this contribution limit does not include the employer match. If you invest $20,500 in your 401(k) and your employer adds $5,000, you're still following the IRS rules.

But there is another limit to think about - the total contribution limit - which includes your contributions and the employer match. For the tax year 2023, this overall contribution limit stands at $66,000 ($73,500 when accounting for catch-up contributions for individuals aged 50 or older). Essentially, the combined contributions made by you and your employer cannot exceed $66,000 in a year. Most employers don't provide such large contributions, so it's unlikely to surpass this limit.

How 401k Match Works

Employees typically contribute a portion of their earnings to their 401(k) accounts. Additionally, employers may also contribute funds to these accounts based on their employees' income levels.

Some companies match employee contributions dollar-for-dollar, but it is more common to see partial matching percentages. In these cases, the company matches a portion of the employee's contributions. For example, if the employee adds $1 to their 401(k) account, the company will contribute $0.50.

Regardless of the structure, your employer usually sets a limit on how much they will match of your income. For instance, your employer might offer a match of $0.50 for every $1 you contribute, up to 6% of your salary. 

Let's say your annual income is $50,000, and 6% of that amounts to $3,000. If you contribute $3,000 to your 401(k), your employer will match it with $1,500. This match can be seen as receiving free money. 

If your company provided a dollar-for-dollar match instead of a partial match, they would contribute $3,000 for the year. You can give more than $3,000 if you want, but your employer won't match any extra money you contribute.

Companies use a vesting schedule to decide who owns employer-contributed funds if an employee leaves the company. Immediate vesting, where you retain all employer contributions to your 401(k) as soon as they are made, is uncommon.

Often, cliff vesting is used. This means if you leave before a certain number of years, you lose all employer-matched funds. Another option is graded vesting, where your company slowly gives you a part of the match each year. For example, they may give you 20% after the first year, 40% after the second year, and so on.

To understand how your 401(k) match works, consult with your employer. Each company has its own method and schedule for matching and vesting.

Contribution Limits

For the year 2023, you have the opportunity to contribute a maximum of $22,500 to your 401(k) account ($20,500 for 2022), unless you are 50 years old or older. In that case, the contribution limit increases to $30,000 ($27,000 for 2022).

Additionally, in 2023, the government has set a cap on the total annual contributions at $66,000, or $73,500 if you are 50 or older. This limit encompasses both your chosen deferrals and the funds matched by your employer. In 2022, these contribution limits stand at $61,000 and $67,500, respectively.

 Most individuals need not be concerned about reaching these contribution limits; however, high-income earners should be cautious. Suppose your company offers a dollar-for-dollar match on up to 6% of your salary, and you earn $400,000 annually. If you are younger than 50, you may not receive the complete match because you need to save $24,000. This amount exceeds the limit set for your 401(k) in either 2022 or 2023.

If you give more money than the government allows, you will have to pay taxes on it twice. The first time is when you give the money, and the second time is when you take it out during retirement.

Make sure you keep track of how much money you have contributed towards the yearly limits. If you are getting close to reaching the limit, withdraw any extra money before the tax deadline. By doing so, you can prevent the occurrence of double taxation.

Bottom Line

Employer matching contributions to your 401(k) don't impact your personal contribution limit.  This is important to understand.  Maximizing what you contribute can help grow your retirement savings without needing to save or earn more money.

If you have any inquiries concerning your 401(k) program and employer match, it is advisable to consult your HR representative. By doing so, you can gain a clearer understanding of how to contribute effectively and determine the appropriate amount to accumulate in your 401(k) for retirement.

Sources:

https://smartasset.com/retirement/does-employer-match-count-toward-the-401k-limit

https://www.fool.com/retirement/plans/401k/company-match/

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This material is provided as a courtesy and for educational purposes only.  Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation.

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