401(k) Match Formulas That Could Boost Participation Without Breaking the Budget

Safe Harbor and Vesting Schedules

Insight By
Chris Burke

401(k) Plans are the cornerstone of employee retirement savings. How can you boost plan participation by matching employee contributions without breaking the bank?  This article outlines three options for you to consider.

Safe Harbor 401(k)

Employers can allocate 3-4% of employee compensation via an annual contribution and avoid most compliance tests.[1] For example, if an employee is contributing to the retirement plan, the employer can match with either:

Basic Contribution
Employee
Deferral
Employer
Match
1% 1%
2% 2%
3% 3%
4% 3.5%
5% 4%
Enhanced Contribution
Employee
Deferral
Employer
Match
1% 1%
2% 2%
3% 3%
4% 4%

Or, employers can make a 3% non-elective contribution to all eligible employees. The advantages of a safe harbor match include:

  • Exempts employers from most annual compliance/non-discrimination tests.
  • Annual contributions to the plan reduce the employer's taxable income.
  • Allows all employees, including those who are highly compensated, to contribute the maximum annual amount to their plan.

Safe Harbor matches are available to any employer with one or more employees, and must be offered to employees 21 or older who have worked at least 1,000 hours in the previous year. (Other restrictions may apply.)

Graded Vesting

Graded vesting allows employers to specify a schedule as to how their match contributions become available to employees. For example, if 20% annual vesting begins after an employee's first year of service, they would be 100% vested in six years.

Employment Years and Vesting Schedule
1YR 2YR 3YR 4YR 5YR 6YR
0% 20% 40% 60% 80% 100%

The advantages of a graded vesting schedule include:

  • Enhances employee loyalty by encouraging them to stay with a company to receive the maximum benefit at the end of the period (maximum vesting period is six years). The vesting schedule applies only to employer contributions as the employees are 100% vested at the time of contribution.
  • If an employee quits before fully vested, they will only be entitled to the correlating amount (percentage) of the employer’s contribution noted in the vesting schedule.
  • Limits employer financial risk by allowing lower amounts to “leave” with an employee if they depart before 100% vested.

Graded vesting schedules are available to any employer with a qualified retirement plan. Graded vesting, however, cannot be used in conjunction with a cliff vesting schedule.

Cliff Vesting

Cliff vesting allows an employer match to vest after a specified amount of time (usually one to three years). At the stated "cliff" date, the entire contribution by the employer vests. For example, a cliff schedule might have zero percent vested after two years of service. After the third year, however, 100% of the employer's contribution vests.

Employment Years and Vesting Schedule
1YR 2YR 3YR
0% 0% 100%

The advantages of a cliff vesting schedule include:

  • Protects employer's contributions since the employee forfeits those dollars if they leave prior to the stated "cliff" time period. Employee contributions vest at 100% at the time of the contribution.
  • Enhances employee loyalty by encouraging them to stay with a company to receive the maximum benefit at the end of the vesting period (maximum cliff vesting period is three years in 2020).[2]

One of these options might be a good fit for you and your employees. Contact us today to learn more about employer match options that are cost effective and can help expand 401(k) participation without busting the budget.

[1] IRS.gov. “Mid-year Changes to Safe Harbor401(k) Plans and Notices.” Feb 21, 2020.

[2] IRS.gov. "Issue Snapshot - Vesting Schedules for Matching Contributions". June 19, 2019.

Insight By
Retirement Plan Consulting
Chris Burke
Vice President
File Number

3182002.1

Topic
Retirement Plans
Published on

October 15, 2020

updated on

October 15, 2020

Disclosure

This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance or tax/legal advice. Each plan has unique requirements, and you should consult your attorney or tax advisor for guidance on your specific situation.

Securities and Investment Advisory Services offered through M Holdings Securities, Inc., a registered Broker/Dealer and Investment Advisor, member FINRA/SIPC. LoVasco Consulting Group is independently owned and operated.

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