Many employers will offer to match a certain amount of contributions an employee
makes to their 401k plan. The terms of matching plan options often vary — some employers
provide very generous match plans, others offer small matching plans or none at
all. Employers are not bound by law (with the exception of some SEP and Simple IRA
plans for small businesses) to contribute to their employee’s retirement plans,
however most choose to do so.
There are a variety of different matching plans employers can choose
to implement, but typically an employer will offer to contribute in one of the following
- Dollar for dollar match for all employee contributions up to a certain percentage
of an employee’s salary ( i.e., 100% of contributions matched up to 6%), or
- A percentage match of employee contributions up to a certain percentage
of an employee’s salary (i.e., 50% of contributions matched up to 8%).
In the case of employer match contributions, the opportunity cost of postponing
retirement savings for current consumption is the amount an individual could be
getting from their employer match for retirement savings. In a sense, not taking
advantage of the maximum amount of contributions your employer is willing to match
is like not taking free money.
Some employers defer the ownership of matched contributions to their employee’s
retirement accounts based on a vesting schedule. In a plan subject to vesting an
individual is matched by an employer for all contributions in a manner similar to
those described above, but a percentage of the ownership of those matches is postponed
for a certain amount of time, referred to as the vesting period.
For example, an employer may do a dollar for dollar match of up to 6% of an employee’s
salary, with a 25% vesting schedule over a vesting period of 4 years. Under this
scenario, the employee is considered 25% vested after the first year, and 25% of
the employer’s matched contributions would be owned by the individual. At the end
of the second year the individual is 50% vested and owns 50% of their employer’s
matched contributions, and so on. By the end of the forth year the employee would
be fully vested, and 100% of all employer contributions would be owned by the individual.
If the employee should leave after their third year of employment, only the amount
of contributions owned by that individual according to the vesting schedule (75%
in this example) would be available for a rollover, and the rest of the contributions
would be retained by the employer.