How a 401(k) match works: It's like receiving free money.

Employer-sponsored 401(k) plans are one of the most intelligent financial tools for saving for retirement. By contributing to these plans, you can reduce your taxable income and potentially place yourself in a lower tax bracket, as contributions are tax-deferred.

Many companies offer 401(k) plans that match employees' contributions, effectively providing free money for retirement.

What you need to know about 401(k) employer matching, including how it works and what's considered a good match, is as follows:

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What is 401(k) matching?

In 2023, 98% of companies that offered a 401(k) plan matched their employees' contributions to some extent, according to the Plan Sponsor Council of America (PSCA).

Although you may contribute 10% of your paycheck to your 401(k), your company only matches the initial 5%.

Employer contributions can be dollar-to-dollar or a partial match, such as 50 cents for every dollar you set aside.

Nathan Boxx, director of retirement plan services at Fort Pitt Capital Group, stated that companies usually offer a full match of up to 3% of an employee's salary, followed by a partial match of 50 cents for every dollar on the next 2%. Employees' contributions above 5% are typically not matched. Some employers contribute at a flat rate, while others require employees to set aside a certain percentage before they begin matching.

What is vesting?

The percentage of your 401(k) contributions that you own outright is known as vesting. While your contributions are always immediately vested, your company may require you to remain at your job for a specified period to receive 100% of the matching contributions. If you depart early, you may lose a portion of that money.

If a plan vests all at once after a specific time frame, it is referred to as "cliff vesting." On the other hand, if it vests gradually, it is called "graded vesting."

Nearly 30% of plans used graded vesting over five or six years, while more than 44% offered immediate full vesting in 2021, according to PSCA.

What's a good 401(k) match?

The range of formulas used for 401(k) employer matches varies, but according to Boxx, a match of between 3% and 5% is generally considered the norm.

Fidelity Investments manages the largest number of 401(k) plans in the country, with 24,800 plans under its care as of March 2023. In the first quarter of that year, the average company match for Fidelity plans was 4.8% of a worker's salary. The most common 401(k) match formula for Fidelity accounts was a dollar-for-dollar match on the first 3% and then 50 cents on the dollar on the next 2%. If a worker contributed 5% of their salary, according to that formula, their employer would be contributing another 4% (or 3% plus half of 2%).

If your employer doesn't offer a 401(k)

With traditional IRAs, investors contribute pre-tax dollars, allowing their money to grow tax-deferred until withdrawal. In contrast, Roth IRAs require taxed contributions before investment, resulting in tax-free growth and withdrawal of funds.

Charles Schwab provides both traditional and Roth IRAs, along with digital resources to assist you in selecting the most suitable option for your requirements. There are no monthly fees and no minimum account balances.

Vanguard provides a range of affordable index mutual funds and exchange-traded funds, along with spreadsheets for tracking retirement costs and income.

How much should you contribute to your 401(k)?

Experts suggest contributing at least the same amount as your employer's match, such as 5% if your company matches dollar-for-dollar up to that amount.

Setting aside 15% of your income for retirement is a good goal, but it may vary based on your age, financial situation, and retirement objectives.

In 2024, the maximum contribution limit on 401(k) plans is $23,000, with workers over 50 able to contribute an additional $7,500 to catch up on retirement planning.

In 2024, the combined employee and employer contribution limit is $69,000.

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Bottom line

Maximizing your employer match should be a significant component of your retirement plan. Strive to contribute enough to receive the full match your company provides.

Meet our experts

Nathan Boxx, director of retirement plan services at Fort Pitt Capital Group, was interviewed for this story at CNBC Select.

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