Guideline supports several types of employer contributions and can help you make an informed decision about the appropriate choice for your 401(k) plan.
Though not required, employer contributions serve as a great vehicle for boosting employees’ retirement saving engagement, improving your 401(k) plan participation rate, and increasing your plan’s likelihood of passing annual nondiscrimination testing.
Employer matching enables an employer to contribute a percentage of employee deferrals up to a self-defined limit. Employers can choose between Safe Harbor and discretionary matching contributions.
A Safe Harbor Matching Contribution, explained in greater detail here, ensures that all eligible employees are provided a fair opportunity to benefit from the plan and exempts plans from annual nondiscrimination testing. The contributions must be be immediately vested.
- Basic Safe Harbor Match: The employer matches 100% of employee deferrals up to the first 3% of compensation, and then 50% of deferrals of the next 2% of each employee’s compensation.
- Enhanced Safe Harbor Match: A more generous match than the Basic Safe Harbor Match, an Enhanced Safe Harbor Match will match deferrals up to and including of 6% of compensation. Matching 100% of an employee’s deferrals up to 4%, 5%, or 6% of compensation are examples of enhanced matches.
Safe Harbor plans may be amended effective January 1st of each year, with notice provided to employees by December 1st. For more information about adding a Safe Harbor provision to your plan, click here.
Discretionary Matching Contributions allow the employer to decide what percentage of employee deferrals to match and the ability to adjust matching amounts as business needs change. Vesting schedules, explained in more detail here, can apply to discretionary matching contributions.
- Example: A company may offer a 25% match of employee deferrals up to 5% of compensation, and the employer may change or suspend this discretionary match at any time.
Matching Calculation Methods
At Guideline, we calculate and collect the employer match on a per pay period basis. However, some 401(k) providers do not do this, and instead require an annualized calculation.
Per pay period calculations provide the most consistency for both employers and employees, and reduce the risk of large payables at the end of the year.
- Example: In a plan offering a 100% match to 4% of compensation for an employee with a gross paycheck of $5,000 who defers 4% of that paycheck, or $200, the employer’s matching contribution will also be $200. Since the match amount is calculated per pay period, employees may receive a different match amount if they change their deferral percentage.
True-Up Contributions may be required for the year that your plan moves to Guideline, if your prior 401(k) provider did not calculate and collect matching contributions on an ongoing basis.
- Example: Consider an employee earning $50,000 per year in a plan offering a 100% match to 4% of compensation. If the employee defers 4% of compensation, or $2,000, over the course of the entire year, then the employer’s matching contribution will also be $2,000 for the year. This is true regardless of the actual contribution each pay period. Now, consider if the employee instead deferred 8% of their compensation in the first 6 months, and then stopped deferring for the remainder of the year. At the end of the year, the employer will have contributed only $1,000 in matching contributions and will need to contribute an additional $1,000 to complete the 4% match - this is known as a "true-up".
Remember, all plans that start the year with Guideline will use a per pay period match and will not need to make additional employer contributions after year end.
Profit Sharing and Non-Elective Contributions
Profit sharing and non-elective contributions are types of contributions the employer makes independent of employees decision to defer into the plan.
Profit Sharing is a a pre tax contribution an employer can choose to make to all employees who are eligible on the last day of the year. Contributions can be allocated to employees proportionally based on compensation, or as a flat dollar amount to all eligible employees. An employer can choose each year whether or not to make a profit sharing contribution. For more information on the benefits of profit sharing, click here.
Non-Elective Safe Harbor Contributions are employer contributions of at least 3% of each employee’s annual compensation made regardless of the employee’s deferral. As with Safe Harbor matching plans, plans making Non-Elective Safe Harbor contributions are not subject to nondiscrimination testing. The nonelective contributions are immediately vested and a plan can elect before December 1st whether to provide nonelective safe harbor contribution for the coming year or not.
Which Employer Contribution is Right For Your Company?
By providing a way for employees to grow their savings tax-free, you are offering an important benefit. Here are some plan design considerations to keep in mind:
- For peace of mind, particularly in small companies, consider a Safe Harbor plan.
- Eliminate the risk of being outside nondiscrimination limits often faced by small companies.
- Ensure that owners and executives can maximize contributions, without refunds.
- To control your company costs, consider Discretionary Matching.
- Encourage your employees to contribute to their retirement saving at a cost that works for you.
- Provide a great benefit that can be adjusted anytime.
- For maximum flexibility, consider Profit Sharing.
- Share successful years with your employees, without creating an obligation.
- Make maximum allowed contributions.
While there is no one-size-fits-all solution for all small businesses, Guideline can help you design an employer contribution that best fits your company needs. Contact us to discuss the right approach for your company!