What Is a QACA Match and How Does It Work for Employers?

Employers looking to incentivize retirement savings among their workforce often turn to Qualified Automatic Contribution Arrangements (QACAs). These arrangements provide a structured way for employers to contribute to employees’ 401(k) plans, enhancing employee satisfaction and retention.

Basic Eligibility for Employer Contributions

To implement a Qualified Automatic Contribution Arrangement (QACA), employers must understand the eligibility criteria for employee participation. Under the Internal Revenue Code (IRC) Section 401(k), employees must generally be at least 21 years old and have completed one year of service, defined as working at least 1,000 hours over a 12-month period. This ensures contributions target committed employees.

Employers can adopt more lenient eligibility requirements, such as lowering the age or service thresholds, to attract younger talent or address high turnover. Any adjustments must comply with regulations to maintain the plan’s qualified status. Clear communication of these criteria is essential to help employees understand their benefits.

The timing of contributions—whether annual, semi-annual, or more frequent—can significantly impact financial planning for both employers and employees. This aspect of QACA design requires careful consideration of the company’s financial strategy and cash flow.

Common Contribution Formulas

Employers have several options for structuring a QACA, each designed to meet regulatory requirements while benefiting employees. The choice of formula can influence participation rates and employee satisfaction.

Safe Harbor Match

The Safe Harbor Match is popular for its simplicity and compliance with nondiscrimination testing requirements. Employers match 100% of an employee’s contributions up to 3% of their compensation, plus 50% of contributions on the next 2%. For example, if an employee contributes 5% of their salary, the employer’s contribution totals 4% (3% + 1%). This formula exempts the plan from certain nondiscrimination tests and encourages higher participation rates. Safe Harbor Matches must be fully vested immediately, which can boost employee commitment.

Basic Match

The Basic Match is a simpler, more cost-effective option. Employers match 100% of an employee’s contributions up to 3% of their compensation. Unlike the Safe Harbor Match, it allows for a vesting schedule, such as a three-year cliff or six-year graded vesting. This approach provides employees with a clear incentive to contribute while giving employers flexibility in managing costs.

Enhanced Match

The Enhanced Match offers a more generous contribution structure, such as matching 100% of contributions up to 4% or 5% of compensation. While more costly, this approach can improve employee satisfaction and retention, particularly in competitive industries. Employers must ensure compliance with nondiscrimination testing and vesting requirements when adopting this formula.

Vesting Schedules

Vesting schedules define when employees gain full ownership of employer-contributed funds, encouraging retention. Common schedules include cliff vesting, where employees become 100% vested after a specific period, such as three years, and graded vesting, which gradually increases the vested percentage over time, often up to six years. These schedules provide flexibility for employers while rewarding employees for continued service.

Auto-Enrollment Features

Auto-enrollment features in 401(k) plans have become a key strategy for increasing employee participation. Eligible employees are automatically enrolled at a default contribution rate, often around 3% of their salary, though employers can set higher rates to encourage greater savings.

Automatic escalation, where contribution rates increase gradually—typically by 1% annually—until reaching a set cap, further enhances savings rates. Employers should clearly communicate these features, allowing employees the option to adjust or opt out.

Nondiscrimination Testing Exemption

A major advantage of a QACA is its exemption from certain nondiscrimination testing requirements, which ensure 401(k) plans do not disproportionately benefit highly compensated employees (HCEs). Plans typically must pass the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests, with failures requiring corrective actions.

By adopting a QACA, employers can avoid these tests if they meet specific requirements, such as providing a Safe Harbor Match or a nonelective contribution of at least 3% of compensation to all eligible employees. This simplifies compliance and reduces administrative burdens. However, employers must maintain these contributions and plan features to preserve the exemption.

Tax Treatment for Employers and Participants

QACAs offer significant tax benefits for both employers and employees. Employer contributions are generally tax-deductible, reducing the company’s taxable income. These deductions are capped at 25% of the total compensation paid to all eligible employees under IRC Section 404. Additionally, employer contributions are exempt from payroll taxes.

For employees, contributions are made on a pre-tax basis, lowering taxable income for the year. Employer contributions are also tax-deferred, with taxes owed only upon withdrawal during retirement. Employees should be aware of required minimum distribution (RMD) rules, which mandate withdrawals starting at age 73 (as of 2023). Failure to comply with RMD requirements can result in penalties.