To match or not to match...is that the question?!
When I speak with plan sponsors about company contributions within their 401(k) Plan, I will undoubtedly receive a response of either "We offer a match” or “We don't offer a match". Although this is an indication of how the 401(k) is designed, company contributions go quite a bit deeper than simply the match-or-no-match conversation. Today's class reviews the different types of company contributions you can offer the employees to customize your retirement plan.
The first and most basic of the company contributions is referenced above and is known simply as the employer match. An employer match is a contribution made to eligible employees who are actively contributing a portion of their compensation to the plan. The matching schedule is typically designed as a percentage of the employee’s contribution to the plan up to a certain limit. For example, you could offer a 100% match (dollar-for-dollar) up to 4% of the employee’s deferral. In this situation, the employer is offering to match the employee’s contribution up to 4% of the employee’s total annual compensation. If the employee contributes more than 4% of their pay to the retirement plan, the employer would not match these contributions.
Many of my plan sponsors would like to incentivize their employees to participate in the plan but they cannot commit to a dollar-for-dollar company match. In this situation, I review the option of what is known as a stretch match. A stretch match is when the employer structures the matching schedule with pennies on the dollar. For example, a plan sponsor could say that they are going to match 25-cents-on-the-dollar up to 8% of the employee’s total compensation. In this situation, the plan sponsor would be incentivizing the employees to contribute more to the retirement plan to receive the maximum employer contribution of 2% of the employee’s total compensation. As you can see, this matching schedule incentivizes the employee to contribute more to the plan than the dollar-for-dollar match with a 4% limit listed above. The stretch matching strategy can offer a more for less situation for the plan sponsor while encouraging the employee to save more for retirement.
These two options are great if you can commit to a company match but what if you just aren't sure? This is when I typically review the option of a discretionary match (also known as the “maybe match”). The discretionary match allows you to wait until the end of the plan year and see if you would like to implement an employer match retroactively. This is a strong option for employers who have unique cash flow situations or for businesses that experience peaks and valleys throughout the years. The discretionary match allows you to sit down with your accountant and see how the business did for the previous year and determine if you would like to match the employees contributions based on the profits available. Besides offering the flexibility of matching or not matching the participants each year, the discretionary match also allows you to see who was contributing to the plan in the previous year so you can determine which employees will be receiving the company match. When committing to a dollar-for-dollar match or stretch match, it may be difficult to forecast the cost associated with the match because you may not be sure which employees will participate and which will opt out of the plan. This is the main reason why many of my plan sponsors opt for the discretionary match.
There final form of company contributions is known as a non-elective contributions (NEC). As discussed already, company matching is a situation where the employee has to be actively participating in the 401(k) as employees who are not contributing to the plan will not receive a company contribution. However, a non-elective contribution is made to all eligible employees regardless of whether they are contributing to the plan or not. This aspect of the 401(k) Plan operates very much like a Profit Sharing Plan. Much like employer matching, non-elective contributions can be included as an annual commitment from the employer or it can be assessed each year to see if the employer would like to make a discretionary contribution. If the employer has committed to making an annual non-elective contribution to the employees, this contribution can be made on a per pay period basis or in a lump sum after the end of plan year.
As you can see, there are different ways to structure your company contributions within the 401(k) Plan and each method has associated strengths and weaknesses. Join us for next week’s class when we discuss how Vesting Schedules can help serve as a retention vehicle for your employees.