This is in contrast to a matching contribution, in which the employer agrees to provide additional contributions only for employees who make salary deferrals to the retirement plan. Another difference is that the employee portion of matching contributions are deducted (deferred) from their paycheck, while nonelective contributions are paid solely by the employer.
Acronyms: NEC, employer NEC
For example, an employer may choose to make a nonelective contribution of 6% of the employee’s salary. That means if the employee earns $50,000 annually, the employer would pay $3,000 per year to the employee’s retirement account. For the employee, it’s like receiving a $3,000 bonus to their retirement savings.
How Do Nonelective Contributions Work?
The Employee Retirement Income Security Act of 1974, or ERISA, is the federal law that specifies standards and requirements for retirement plans in private industry. Employers are not required to establish a retirement plan for their workers. But those who do have to comply with the minimum standards set by ERISA. In many cases, the employer can choose the type and amount of contributions they make on behalf of employees, as long as they don’t exceed annual contribution limits as set by the IRS. However, some retirement plan types require employers to meet specific contribution amounts. One example of this is a Safe Harbor 401(k). A Safe Harbor 401(k) requires the employer to either:
Match 100% of employee contributions up to 3% of earnings (plus 50% of the next 2%), orMake nonelective contributions equaling 3% of compensation for every eligible employee
Under an automatic enrollment 401(k), the employer must either:
Match 100% of employee contributions up to 1% of compensation (plus 50% of contributions above 1% and up to 6% of compensation), orMake nonelective contribution of 3% of compensation for all participants
A SIMPLE 401(k) is another type of 401(k) plan that limits employer contributions to either:
Make 100% matching contributions up to 3% of employee pay, orMake a nonelective contribution of 2% of pay for every eligible employee
Advantages and Disadvantages of Nonelective Contributions
Nonelective contributions benefit workers by allowing them to boost their retirement savings beyond what they may have achieved on their own. This can act as an incentive for employees to stick with a company while at the same time helping the business attract and retain employees. Another major benefit for businesses is that nonelective contributions are tax-deductible for the employer. Nonelective contributions promote inclusivity by requiring employers to contribute for all employees rather than just highly-compensated ones. Additionally, participation in Safe Harbor 401(k) and SIMPLE 401(k) plans allow businesses to avoid annual compliance testing. One potential downside for employers is the added administrative costs that go along with sponsoring a plan. Employers must make sure to remain compliant with all rules and regulations, maintain fiduciary responsibility, and keep up with making the required contributions in a timely manner. Want to read more content like this? Sign up for The Balance’s newsletter for daily insights, analysis, and financial tips, all delivered straight to your inbox every morning!
