Contributing enough to the 401k plan in order to get the full employer match is among the most basic rule in saving and investing. When it comes to matching your 401k contributions, employers can do it in several different ways.
Suppose your employer matches dollar for dollar on the first 4% of pay and your pay is $120,000 per year. With 24 pay periods in a year, your gross pay is $5,000 per pay period. If you contribute $200 per pay, which is 4% of $5,000, your employer matches another $200. Over the course of a year, your employer will match $4,800. Now, if you contribute $1,000 in the first pay period of the year, should your employer match $1,000 because it’s still below 4% of your pay for the year?
No, because even though your annual pay is $120,000, your employer doesn’t know whether you will work the entire year. If you quit right afterwards, you will have earned only $5,000, and the employer should only match $200. So the employer only wants to match $200 in the first pay period of the year, not $1,000. In the next pay period, same thing, you earn $5,000 and contribute $1,000, and the employer matches $200.
Some employers make it simple for themselves and they just operate on a per-payroll basis. Whatever you earn and contribute in a pay period, the employer just calculates the match based on those. This method is easiest for the payroll software but it creates a problem for employees who max out the 401k contributions.
To continue the previous example, you contribute $1,000 per pay period and the employer matches $200. This goes on until you max out your $19,000 annual contribution in the 19th pay period. In pay period 20, your contribution stops and the employer match also stops. Over the course of the year, you only received $200 * 19 = $3,800 in employer match, not the $4,800 you expected. When the employer operates on a per-payroll basis, you have to make sure you contribute at least 4% of pay through the last pay period. If you max out too soon, you miss out on the match. It can be tricky if your pay varies from pay period to pay period or if you get a surprise bonus in the middle of the year.
To make life easier for the employees, some employers will do an extra calculation after the end of the year. In our previous example, when the employee maxed out too early and only received $3,800 in 401k match, the employer will contribute additional $1,000 in the following year to make up the difference. This is called a true-up contribution. This way the employees won’t have to worry about adjusting their contribution percentages to make sure they don’t max out too early. You can front-load their 401k contributions and still receive the full match.
However, besides making you wait until the following year to receive the true-up match, some employers impose another requirement for the true-up match. You only get the true-up match if you work through the end of the year. If you max out your contribution in May and you quit in September, you will get less match than if you make your contributions last through September. This saves the employer a little money on the employees who maxed out before they quit.
Not all employers have this silly requirement. If your employer gives a true-up match and it isn’t limited to employees who work through the end of the year, after you quit, you should wait for the true-up match before you roll over your 401k money.
True-Up Every Payroll
Employers who are more current with the best practice give a true-up match every payroll. In our previous example, when your contribution stops in pay period 20, the employer sees you made $100,000 and you contributed $19,000 year-to-date. The employer should match $4,000. Therefore the employer matches another $200 in pay period 20 even though your contribution is zero. This continues through the end of the year. If you quit, the employer match also stops. You always get the promised match.
In terms of employee-friendliness, the employer match practices go in this order, from least friendly to most friendly:
- Every payroll with no true-up: Employees must watch and adjust the contributions throughout the year.
- Annual true-up with end-of-year requirement: Employees who maxed out early and quit are deprived of the full match.
- Annual true-up without end-of-year requirement: Employees who maxed out early must wait for the true-up in the following year.
- True-up every payroll: Employees always get the full match in real time.
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