Understanding Nonelective Contributions: Benefits and Drawbacks

What is a nonelective contribution?

A nonelective contribution is an employer-funded deposit to an employee’s retirement plan that the employer makes regardless of whether the employee contributes. These contributions are typically fully vested and intended to boost employee savings, help meet nondiscrimination rules, and incentivize plan participation.

How nonelective contributions work

• Employers set a contribution rate (for example, 3% of pay) and contribute that percentage for each eligible employee, independent of any employee deferral.
• Example: If an employer contributes 3% and an employee earns $50,000, the employer adds $1,500 that year.
• Employers may change contribution rates at their discretion, subject to plan rules.
• IRS limits on total contributions apply (see “Contribution limits” below).

Contribution limits (examples)

• Elective deferral limit to a 401(k) (employee pre-tax/ROTH contributions): $23,000 for those under 50 in 2024; those 50+ may make catch-up additions (e.g., $7,500 in 2024).
• Total contributions to a defined-contribution plan (employee + employer) have a higher annual limit (for example, $69,000 for those under 50 in 2024, plus catch-up amounts for older participants). Check current IRS guidance for the latest limits.

Benefits

For employers

• Tax-deductible business expense.
• Can increase employee participation and retention.
• Offering fully vested nonelective contributions can satisfy safe harbor rules and exempt the plan from certain nondiscrimination testing.

For employees

• Retirement savings increase with no action required.
• Contributions are typically fully vested immediately, giving employees immediate ownership.

Drawbacks and considerations

For employers

• Higher payroll costs compared with plans that use matching only.
• Administrative burden and fiduciary responsibility for selecting default investments for nonenrolled participants.
• Employers must choose appropriate Qualified Default Investment Alternatives (QDIAs) — commonly target-date funds, balanced funds, or professionally managed accounts — and document due diligence.

For employees

• Nonelective contributions may be smaller than what an employee could receive from a generous matching formula (e.g., a 5% match).
• Default investments chosen by employers may not suit every individual’s risk tolerance or retirement timeline.

Safe harbor and corrective nonelective contributions

• Safe harbor nonelective contributions: To qualify for safe harbor protection, employers can make a nonelective contribution of at least 3% of compensation to each eligible employee (fully vested), which exempts the plan from certain nondiscrimination tests.
• Corrective nonelective contributions: If an employee lost the opportunity to make elective deferrals (for example, due to an administrative error), the employer may make a corrective nonelective contribution to compensate that participant. These corrective contributions are required to be fully vested.

Plan-design tips

• Evaluate overall workforce demographics before selecting default investments or QDIAs; one-size-fits-all options like target-date funds may not be ideal for every employee.
• Compare costs and intended outcomes of nonelective contributions versus matching formulas to align plan design with budget and retention goals.
• Document fiduciary processes for selecting QDIAs and review them periodically.

Conclusion

Nonelective contributions are a straightforward way for employers to boost employee retirement savings and simplify compliance with nondiscrimination rules. They offer immediate, fully vested benefits to employees and tax advantages to employers. However, they increase employer costs and require careful plan design and fiduciary oversight. Employers should weigh budget, workforce needs, and administrative capacity when deciding whether to use nonelective contributions or alternative contribution strategies.