Compare matching and nonelective contributions through employer cost, employee access and payroll administration. Keep safe harbor requirements separate.
February 19, 2024 · Financial Forte Staff
Historical article: prepared retrospectively using information available as of February 19, 2024.
An employee asks whether the company “matches the retirement plan,” and the answer sounds straightforward until someone checks the document. The business contributes to the plan, but the contribution doesn't depend on what employees save. That is a meaningful benefit, yet calling it a match can give employees the wrong idea about how to receive it.
A matching contribution and a nonelective contribution do different jobs. Understanding the distinction helps an employer budget accurately, communicate clearly and choose a design that fits the workforce. It also helps avoid administering one arrangement as though it were the other.
Explain what triggers the employer contribution
A match is tied to an employee's eligible contributions under the plan's formula. A nonelective contribution can go to eligible participants whether or not they make their own deferrals. The plan document determines the details, including the compensation used and any applicable conditions.[1]
That difference matters to someone unable to contribute from a paycheck. Under a matching design, that employee may receive no match. Under a nonelective design, the employee may receive an employer contribution despite not deferring, if the plan's eligibility and allocation requirements are satisfied.
Neither structure is inherently more generous in every situation. The formula, eligible compensation, participation and other plan terms determine the actual dollars. A larger percentage advertised without those details can be misleading.
Use plain language in employee communications. Explain what employees must do, what the employer will do and where the governing details can be found. Have the payroll team use the same terminology as the document and notices.
Compare the cost under more than one participation assumption
Consider a hypothetical employer with twelve eligible employees, each earning $40,000 in plan-eligible compensation. Total compensation is $480,000. For illustration, the company compares a match of 100 percent of employee deferrals up to 3 percent of compensation with a 3 percent nonelective contribution.
If all twelve employees defer enough to receive the full illustrative match, employer contributions would total $14,400: $480,000 multiplied by 3 percent. If only six do so and the other six defer nothing, the match would total $7,200, assuming identical compensation and no other relevant conditions. If participation improves from that case to all twelve employees, the illustrated annual employer match doubles. Budgeting should anticipate the intended success of the benefit.
The illustrative nonelective contribution would total $14,400 for all twelve eligible employees regardless of whether they defer. These figures omit fees and other plan costs and are not a statement that either simple formula satisfies every requirement of a particular plan design. Employees who cannot currently afford to defer would still receive the illustrated nonelective contribution if eligible; that workforce objective can justify its higher modeled cost.
The lower matching expense in the second scenario comes from fewer employees receiving the contribution. The employer should decide whether that result fits its purpose, rather than treating lower participation as a budgeting success.
If the goal is to encourage employees to begin saving, a match may support that message. If the goal is to provide a baseline employer-funded benefit across the eligible workforce, a nonelective contribution may better express it. Either approach still needs understandable communication and an affordable funding plan.
Keep safe harbor status separate from a familiar percentage
A safe harbor 401(k) is a design that can satisfy certain nondiscrimination requirements through specified contributions and other conditions. It is not simply any plan that makes a contribution called a match or uses a percentage that sounds familiar.[2] The ordinary 100%-up-to-3% matching example above is not being represented as a compliant safe harbor matching formula.
Ask the administrator whether the proposed design is ordinary or safe harbor, which tests or exceptions apply, and what conditions must be maintained. Applicable vesting, notices and contribution requirements depend on the design. Do not promise that safe harbor status eliminates all testing, reporting or fiduciary responsibilities.
Vesting determines when an employee has an unconditional right to employer contributions. An ordinary employer contribution may have a permitted vesting schedule, while safe harbor arrangements have particular requirements. Have the administrator explain the actual terms rather than assuming all employer money is immediately vested or all designs permit a long service requirement.
A vesting schedule may be part of a retention discussion, but it should not substitute for a benefit people understand and value. Nor should the employer assume that the schedule alone causes employees to stay.
Align payroll and communications with the choice
Before implementation, walk through several employees' situations. Include an employee who defers nothing, one who changes the deferral rate during the year and one whose compensation includes a bonus. Confirm the calculation in each case using the actual plan document.
Ask whether contributions are calculated each payroll or over the year and whether the design includes an annual reconciliation. An employee who concentrates deferrals early in the year can be affected by those details. The employer's payroll configuration must match the promise made in the plan.
Document the person responsible for the calculation, the person who reviews it and the provider's role in correcting errors. Where fiduciary duties apply, prudent oversight includes monitoring the services used to operate the benefit and addressing discrepancies. Buying administration services is not the same as confirming they are being delivered correctly.[3]
Measure whether the design is doing its job
Review participation, the share of employees receiving an employer contribution, total cost and recurring employee questions. These measures can show whether the design is reaching the intended workforce and whether the explanation needs improvement.
Begin by asking the administrator for a one-page comparison using your actual census. Then compare full participation with a realistic lower-participation case. A contribution design is easier to defend and maintain when the business understands both whom it helps and what it will cost as employee behavior changes.
Related reading
- Safe Harbor 401(k) Planning Starts Before the Fall Rush
- Profit Sharing Can Reward Employees Without Becoming a Cash Bonus
Have more questions about your employer contribution design? Email Dave at dave@financialforte.com to discuss your questions and next steps.
The contact invitation is current; it does not imply this contact path existed on the historical reference date.
Educational information, not personalized investment, tax, legal or benefits advice. Examples use hypothetical assumptions. Verify current rules and your circumstances before acting.
Sources
- [1] Retirement Plans for Small Business — Publication 560 (2022) — 2023-03-17; 2022 edition; What You Should Know About Your Retirement Plan — September 2021 edition
- [2] Retirement Plans for Small Business — Publication 560 (2022) — 2023-03-17; 2022 edition
- [3] Meeting Your Fiduciary Responsibilities — September 2021
