Login
One of most effective ways an employer can persuade their employees to participate in a 401(k) plan is by matching a portion of their pre-tax or Roth 401(k) salary deferrals. This is unsurprising when you consider matching contributions are like a guaranteed return on salary deferrals - or “free” money.
Yet, despite their indisputable benefit to employees, matching contributions are not the best fit for every 401(k) plan. Sometimes, nonelective contributions like profit sharing – which don’t require employees to do anything to receive a contribution - are the better alternative. If you’re a 401(k) plan sponsor, you want to understand your company’s matching contribution options. To meet certain 401(k) goals, they can be tough to beat.
Matching contribution basics
Employer matching contributions are only made to 401(k) plan participants that make salary deferrals (pre-tax or Roth) themselves. Typically, the formula for calculating a matching contribution is based on a percentage of salary deferrals up to a specified compensation limit – for example, 50% of salary deferrals up to 6% of the employee’s eligible compensation – for a 3% maximum match. A match formula can also have multiple tiers – for example, 100% of deferrals up to 2% of compensation plus a 25% match on deferrals between 2% and 10% (4% total).
Regardless of their formula, matching contributions can be made to 401(k) plan participants on a per payroll basis or following the close of a plan year.
Safe harbor matching contributions
Safe harbor 401(k) plans are the most popular type of 401(k) plan used by small businesses today. They automatically pass annual ADP/ACP and top heavy tests and allow business owners to make salary deferrals up to the legal limit ($23,500 + $7,500 catch-up for 2025) without the risk of corrective refunds or contributions. For a 401(k) plan to achieve safe harbor status, the employer must make a qualifying contribution to eligible employees.
For a matching contribution to meet safe harbor 401(k) requirements, it must use one of the following three formulas:
- Basic match - 100% on the first 3% of compensation plus a 50% match on deferrals between 3% and 5% (4% total).
- Enhanced match – Formula must be at least as generous as the basic match at each tier of the match formula and can’t be based on more than 6% of compensation. A common enhanced formula is 100% match on the first 4% of compensation.
- QACA match - A Qualified Automatic Contribution Arrangement (QACA) is a special type of automatic enrollment arrangement that also satisfies safe harbor 401(k) contribution requirements. The minimum QACA match formula is 100% on the first 1% of compensation plus a 50% match on deferrals between 1% and 6% (3.5% total).
An employer may also make discretionary a matching contribution on top of these contributions and remain exempt from ADP/ACP and top heavy testing if the match meets both of the following two requirements:
- Its formula is not based on more than 6% of compensation.
- Its dollar amount doesn’t exceed 4% of compensation.
Other safe harbor match requirements
- Basic and enhanced matching contributions must be subject to 100% immediate vesting, while the QACA match can be subject to a 2-year cliff vesting schedule. The extra discretionary match can be subject to either a 3-year cliff or 6-year graded vesting schedule.
- A 401(k) plan can’t require participants to be employed on the last day of a year or work a minimum number of hours to receive a safe harbor match for the year.
Non-safe harbor matching contributions
Employer matching contributions that don’t meet the safe harbor 401(k) requirements must pass the Actual Contribution Percentage (ACP) test to be considered nondiscriminatory. That’s the bad news. The good news is that non-safe harbor 401(k) plan matches are subject to fewer restrictions, including:
- They can be discretionary - so employers can use different formulas every year or make no contributions at all.
- They can be based on a high percentage of compensation – which makes a “stretch match” strategy possible:
- Under this strategy, employers base their match formula on a high percentage of compensation so plan participants must defer at a high rate to receive the full match – for example, 25% of salary deferrals up to 12% of compensation – for a 3% maximum match.
- They can be subject to either a 3-year cliff or 6-year graded vesting schedule.
- A 401(k) plan can require participants to be employed on the last day of a year or work a minimum number of hours to receive a non-safe harbor match for the year.
When to use matching contributions
Employers commonly use matching contributions to meet the following 401(k) goals:
- Incentivize employees to make salary deferrals themselves.
- Help pass the Actual Deferral Percentage (ADP) test.
- Meet safe harbor 401(k) contribution requirements with the least possible expense – possible when low plan participation by employees makes a safe harbor matching contribution less expensive than the 3% safe harbor nonelective contribution.
However, nonelective contributions may be the superior alternative when trying to meet the following 401(k) goals:
- Provide a base retirement benefit to low wage workers that can’t afford to save themselves
- Maximize business owner contributions with the least possible expense – often, a new comparability profit sharing contribution is less expensive than a matching contribution in meeting this goal.
Matching contributions can be a powerful tool in meeting your 401(k) goals!
While 401(k) matching contributions can be very effective in motivating workers to make salary deferrals themselves, they can also help employers meet various 401(k) goals – like passing the ADP test or meeting safe harbor 401(k) requirements at the lowest possible cost.
If you’re a 401(k) plan sponsor, you should understand your match options – and when nonelective contributions are the better alternative. This knowledge can help you design a 401(k) plan that best fits the needs of your company and employees.