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401(k) Match: 'Thresholds' Drive Participation More than Rates
Sidebar: A sampling of the wide variety of matching formulas

By Stephen Miller, CEBS  7/19/2012

In a 401(k) or similar defined contribution plan, the "threshold" is the limit at which participant contributions are matched by the employer. According to a new report, a higher match rate (for instance, offering an employer match of 80 percent, rather than 50 percent, of an employee's contribution up to 6 percent of salary) has only a small effect on savings plan contributions. In contrast, raising the match threshold (for instance, matching 50 percent of an employee's contribution up to 10 percent of salary, rather than up to 6 percent) has a substantial impact.

That's probably because "[the threshold] serves as a natural reference point when individuals are deciding how much to save, and may be viewed as advice from the savings program sponsor on how much to save," according to Brigitte C. Madrian, the Aetna Professor of Public Policy and Corporate Management at the Harvard Kennedy School of Government. She is the author of a July 2012 report, Matching Contributions and Savings Outcomes: A Behavioral Economics Perspective, from the National Bureau of Economic Research, a nonprofit organization that undertakes economic research on behalf of public policymakers, business professionals and the academic community.

Moreover, changing the matching formula from, say, "50 percent of the first 6 percent of salary" to "25 percent of the first 12 percent of salary" would not increase the cost to the employer but is likely to result in employees saving more—although without effective communications there is a risk that employees might perceive the lower rate/higher threshold as a match reduction.

The report reviewed a large body of research literature focused on encouraging individuals to increase their savings. The approaches undertaken included changing the structure of the match within a savings plan and introducing variations in which some individuals were offered a more generous match than others.

Auto Enrollment and Other Features

While including a matching contribution increases 401(k) savings plan participation and contributions, it has less impact than implementing automatic enrollment or taking other behavioral approaches, according to Madrian's research.

"Behavioral approaches to changing savings plan outcomes—including automatic enrollment, simplification, planning aids, reminders and commitment features—potentially have a much greater impact on savings outcomes than do financial incentives, often at a much lower cost," she observed.

By far the most effective method to increase participation in defined contribution plans is automatic enrollment, her research indicates. Even so, "Matching is not completely irrelevant in plans that have automatic enrollment. A more generous match is associated with higher participation rates," Mandrian found.

Automatically enrolling new employees into employer-provided 401(k)s, 403(b)s and other defined contribution plans has grown steadily more popular in recent years and now is used by 39 percent of employers, according to the Society for Human Resource Management's 2012 Employee Benefits survey report.

Default Contribution Rate Impacts Savings

However, "Although automatic enrollment leads to unambiguous increases in savings plan participation, its effects on savings plan contributions depend very much on the default contribution rate at which individuals are automatically enrolled," Mandrian noted. "Just as the match threshold for savings plan contributions attracts the largest share of savings plan participants when there is a match, so too does the automatic enrollment default contribution rate when there is automatic enrollment. Contributions are higher with a higher default contribution rate under automatic enrollment than with a lower default contribution rate."

For instance, in one study that Madrain described, "with a default contribution rate of 6 percent of pay, which coincides with the match threshold, almost half of employees contribute 6 percent of pay to the plan."

A Wide Variety of Matching Formulas

The investment discussion site Bogleheads.org, based on the investment philosophy of former Vanguard Investments founder and CEO John Bogle, recently asked participants "What retirement contributions does your employer offer?" The responses point to the wide variety of match rates provided by different employers. Here's a sample of the replies:

I'm required to contribute 5 percent of my stated salary and my employer contributes 10 percent.

My employer matches 50 percent up to 8 percent of 401(k) contributions.

4 percent employer/4 percent (mandatory) employee contribution into a defined contribution plan.

401(k) match is 75 percent of first 8 percent of salary.

100 percent match up to 3.5 percent of salary to 401(k).

50 percent employer match up to a maximum of $1,500.

My previous employer contributed 15 percent of salary whether I contributed anything at all. My current employer contributes 2 percent of salary whether employees contribute or not. My spouse's employer contributes nothing.

My previous megacorp employer offered 50 percent up to 8 percent of my contribution to my 401(k). My current smallish company (I'm a software engineer) contributes 25 percent of my gross salary to my 401(k) whether I contribute anything or not. I don't believe that the contribution rate is to offset other risk at the company—we are told that it is to attract and retain top talent in a highly competitive marketplace. In many places, "our people are our best asset" is simply a feel-good bromide. My company seems to actually believe it.

My company contributes 10 percent of gross salary.

My employer doesn't have a hard cap on the percentage of contributions matched; it matches 50 percent up to the federal participant contribution limit of $17,000 per year.

I always thought something like 50 percent up to 6 percent was standard and felt like I got a great deal. I get 100 percent up to 6 percent, plus a nonelective 3.5 percent (increases a little bit with long service times). Seeing what other people are getting, that seems decent but by no means overly generous.

I never had a match or employer contribution of any kind.

About two in five workers are in 401(k) plans that match up to 6 percent, and 10 percent match more than that, according to federal data as reported by the Wall Street Journal.

Most plan sponsors match 50 cents for every dollar participants contribute. About 9 percent match 51 cents to 99 cents on the dollar, and 36 percent match at 100 percent.

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How Match Formulas Make a Big Difference

The design of 401(k) plans can vary significantly, and even small differences in an employer match formulas can add up to hundreds of thousands of dollars over the course of a career, reported Bloomberg Businessweek.

Consider an employee with a starting salary of $31,000 at age 25, who is then granted annual pay increases of 3 percent, reaching a final salary of $101,123 at age 65: Assume she made the average contribution for her age and that the portfolio generated an annual return of 5 percent. Under those conditions, she would have $999,231 if she worked at DuPont, where the top corporate match is 6 percent and the company kicks in an additional 3 percent of pay (DuPont also counts bonus pay when calculating its match). The same person would end up with $504,684 if she worked at Wynn Resorts, where the maximum match is $500, according to the Employee Benefit Research Institute.

As regards generous matching formulas, McDonald's matches 300 percent of the first 1 percent employees save in their 401(k) accounts. The company then matches 100 percent of the next 4 percent of pay an employee contributes, and in recent years also has made a discretionary profit-sharing contribution of 2 percent.

Stephen Miller, CEBS, is an online editor/manager for SHRM.

Related Articles: 

401(k) Match Thresholds and Default Rates Affect Savings, SHRM Online Benefits, May 2013  

Encourage Employees to Defer Adequate Pay to 401(k)s, SHRM Online Benefits Discipline, May 2012

Educate Employees on 401(k) Contribution Limits and Matches, SHRM Online Benefits Discipline, March 2012

Auto Enrollment Boosts 401(k) Participation Among Minorities, SHRM Online Benefits Discipline, October 2011

Report: Driving Improved Savings Behaviors, SHRM Online Benefits Discipline, October 2011

401(k) Automatic Enrollment: Does It Help or Hurt Savings?, SHRM Online Benefits Discipline, July 2011

Automatic Enrollment 'Safe Harbor' 401(k)s: An Exemption from Compliance Testing, SHRM Online Benefits Discipline, January 2010

The Business Case for 401(k) Automatic Enrollment, SHRM Online Benefits Discipline, July 2008

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