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Financial Planning, Retirement

An Unintended Consequence Of The Contribution Match

9/7/18 8:00 AM

iStock-626627280.jpgThere are many reasons why Americans participate in 401(k) plans, e.g. automatic enrollment and tax flexibility, but perhaps the biggest savings incentive is the employer match. Indeed, a growing number of businesses will match their workers’ retirement plan contributions up to a predefined ceiling. This “free money” can provide a significant boost to what workers are able to set aside for retirement each year. However, too many participants that utilize the match do not have a large enough paycheck deferral to take full advantage of it. An earlier report from Fidelity Investments, for instance, found that roughly one in five workers are not contributing enough to their 401(k) plan to receive 100 percent of the match offered by their employer. Many of these participants were encouragingly only 1 or 2 percentage points away from receiving the full match, but over time such behavior can still result in thousands of dollars in forgone matching contributions.

Another problem arises when participants contribute enough to take full advantage of the match but little if anything more. Indeed, a common 401(k) match is “100 percent of the first 6 percent,” and many workers will respond to this by setting their deferral rate to that 6 percent level even though financial experts typically recommend setting aside at least 10 percent of income each year in order to achieve a comfortable retirement. A recent multi-part study by J.P. Morgan suggests that a misunderstanding of what the matching percentage means can explain why many workers are not saving enough. Specifically, 30 percent of surveyed 401(k) participants said that they believe the percentage of salary being matched is what their employer recommends as a target contribution rate. Nearly a fifth of respondents even misinterpreted the salary match percentage to be exactly what their employer “thinks they should be saving,” and 21 percent admitted that they currently set their contribution rate to what their employer will match. Fortunately, participants seem willing to make adjustments to their deferral rate if informed by their employer that the match program is potentially having an undesirable impact on their savings.

For example, 20 percent of surveyed workers said that employers should send a targeted communication to any participants not saving enough for retirement, and 27 percent supported firm-wide notices from employers about why higher contribution rates are needed. Interestingly, a 40 percent plurality of surveyed participants supported “stretching the match.” In such a scenario, assume that an employer currently matches contributions dollar-for-dollar up to the first 6 percent of an employee’s salary. Stretching the match would mean the formula is altered so that 50 cents on the dollar saved is now matched up to 12 percent of salary. As a result, employees in this example could still get a match totaling 6 percent of their salary, but they would instead have to defer 12 percent of their paycheck to get it. This simple trick allows employers, at no additional cost, to nudge workers into setting aside a more substantial amount of money each year that will better prepare them for retirement.



Sources: J.P. Morgan

Post author: Charles Couch

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