A GUIDE TO EMPLOYER CONTRIBUTIONS
Many employers are looking for ways to enhance their 401(k) plans. One of the best ways to do this is by offering some type of employer contribution to plan participants. Employers can contribute to the ADP TotalSource Retirement Savings Plan (the “Plan”) in two ways: matching employee contributions and making contributions on behalf of all eligible employees, regardless of whether they contribute, also known as nonelective contributions.
Matching contributions
Matching is a valuable benefit that many employees look for – and often expect – from employers. When an employees’ contributions are matched by the employer, it can make a huge difference in their savings when they retire.
How do matching contributions work?
A match means an employer puts money into an employee’s Plan account based on what the employee contributes. Full contributions, partial contributions or a combination of both may be used. Typically, the formula for calculating a matching contribution is based on a percentage of salary deferrals up to a specified compensation limit. When matching contributions, employers can choose to match contributions every pay period or make one lump-sum match per year. Payroll matching is the most common matching formula that employers use. In the Plan, when your company elects to offer an employer match, it is calculated automatically in the ADP payroll system based on your eligible employees’ contributions and sent directly to Voya. No additional work is required by the company to ensure the contributions post to participant accounts.
Match contribution types
In general, there are two types of matching contributions: full match and partial match.
- Full match – A full 401(k) match, also known as a dollar-for-dollar match or 100% match, is when an employer matches every dollar an employee contributes to the Plan up to a certain limit. For example, an employer may match dollar-for-dollar up to 6% of an employee’s salary. In this scenario, if an employee contributes 3%, the employer matches 3%. If an employee contributes 8%, the employer matches 6%. The most common dollar-for-dollar contributions are 5% or 6%.
- Partial match – A partial 401(k) match is when an employer matches a portion of every dollar an employee contributes to the Plan up to a certain limit. For instance, an employer might match 50% of an employee’s contribution up to 4% of their salary. In this scenario, if an employee contributes 4%, the employer match equates to 2%. If the employee contributes 2%, the employer match equates to 1%.
Safe harbor plans
Safe harbor plans are the most popular type of 401(k) plan used by small businesses today.1
Employers can automatically meet compliance requirements by offering matching or safe harbor contributions, reducing the need for specific IRS annual testing 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 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%.
Nonelective contributions
Nonelective contributions are contributions an employer chooses to make to Plan accounts, even if an employee isn’t personally contributing to the Plan. Nonelective contributions can provide a boost to all employees’ retirement savings and be especially beneficial to those who may not yet be in a position to contribute on their own.
How do nonelective contributions work?
Nonelective contributions provide employers with quite a bit of flexibility, as they can choose the contribution type and amount each year, depending on business conditions. Once elected, the contributions must apply to all eligible employees and remain in place for the entire year. While nonelective contributions can be added to a plan mid-year, it will require a lump sum “true up” the following year to make employees whole for the period before the contribution was added.
Nonelective contribution types
In general, there are two types of nonelective contributions: safe harbor nonelective and profit sharing.
Safe Harbor Nonelective
The safe harbor plan provision requires an employer to make minimum contributions to employees’ accounts that are immediately vested.* The Plan will provide employees a notice each year that explains the provision. As a result, the plan automatically satisfies certain nondiscrimination requirements.
For safe harbor nonelective contributions, employers must contribute at least 3% of each employee’s annual compensation for all eligible participants or with an HCE exclusion** (regardless of whether they contribute); made per pay period or year end, as long as they do not exceed IRS contribution limits. Additionally, the contribution cannot be changed at any point in the year without the plan losing safe harbor status.
* Safe Harbor Plans meeting QACA requirements can opt for a 2-year cliff vesting schedule instead of immediate vesting schedule.
** With this option, contributions can only be made at the end of the plan year.
Profit Sharing
Simply put, a profit-sharing contribution is essentially a discretionary contribution employers can elect to make to employees’ Plan accounts at the end of the year. Unlike other nonelective contributions, which require a 3% minimum, profit sharing allows employers to determine the amount of contributions to make at the end of the year, and there is no minimum amount. If your business does well one year, you can elect to make a contribution. If there isn’t money in the budget the next year, you simply don’t have to make a contribution.
Other key advantages of a profit-sharing provision include:
- Every eligible participant receives the same ratio of their eligible compensation with the option to provide additional money for compensation earned over the Social Security Taxable Wage Base (TWB).
- Profit sharing contributions can help in the recruitment process, as well as aid in retaining valuable employees.
- Profit sharing contributions may be tax deductible for employers.
Tax benefits
Employer contributions are generally 100% tax deductible for employers, up to the annual corporate tax deduction limit on all employer contributions. Even though they are deductible by the company, employer contributions are not included in the employee’s gross income until distributed, and they are exempt from both the employer and employee portions of Federal Insurance Contributions Act (FICA) Medicare and Social Security, Federal Unemployment Tax Act (FUTA), and other payroll taxes. All contributions have the added upside of being able to grow tax-deferred, and possibly tax-free for qualified Roth distributions, over time.
Vesting schedules
Vesting schedules allow employees to gain ownership of employer contributions after a certain time or gradually over several years. This waiting period entices employees to stay with their employer longer because they may lose unvested Plan benefits if they leave prematurely. As with matching, employers have different vesting options.
Types of vesting schedules in the ADP TotalSource Retirement Savings Plan
- Cliff vesting – An employee becomes 100% vested after three years. For example, employees must wait until they’ve been with their employer for three years to fully own matching contribution benefits.
- Graded vesting – Ownership of matching contributions is earned gradually over a period of five or six years. For example, an employer may use a five -year graded schedule to vest 20% of contributions each year, so an employee is fully vested after five years.
- Immediate vesting – The most attractive and beneficial schedule for employees is immediate vesting. They gain full ownership of matching contributions without a waiting period.
In a traditional safe harbor plan, employer contributions must vest immediately. In QACA plan, employer contributions can be subject to a maximum two-year cliff vesting schedule.
IRS Limits
Every year, the IRS determines limits that are applied to the Plan. While there are limits specific to how much employees can contribute to the Plan annually, there are other limits that impact employer contributions.
- Compensation2 – In 2025, the IRS limits the amount of compensation that may be considered eligible for contributions (including employee before-tax and Roth, employer matching, and employer discretionary profit sharing) under a qualified retirement plan to $350,000.
- Maximum contributions2 – The annual maximum amount that may be contributed to the Plan (including employee before-tax and Roth, employer matching, and employer discretionary profit-sharing contributions) is the lesser of $70,000 or 100% of compensation in 2025. Catch-up contributions are in addition to this limit.
One of the most common reasons companies make employer contributions is to attract and retain talent. As the employer, you also get the tax benefit. As expected, the biggest downside to making some type of employer contribution is the cost. It simply costs money and there is no way around that. Contributing to your employees’ Plan accounts will affect the bottom line, even if it is tax-deductible.
While there are downsides to making employer contributions to the Plan, there are also very compelling reasons why you should at least consider it. If you have questions about the benefits of employer contributions or would like to add it to your Plan, please contact your dedicated 401(k) Specialist at (844) 448-0325.
