Finding the Right 401(k) Match

Matching employee contributions to a 401(k) plan can yield a number of benefits for employers—higher plan participation, employee good will and engagement, and an easier time when it comes to regulatory compliance. However, matching contributions can also be a significant cost to the employer.

For many organizations, the decision is not whether to match but how much to match if they want to keep up with their peers. Nearly three-quarters (74 percent) of employers provide some level of matching contribution, according to the Society for Human Resource Management’s (SHRM’s) 2014 Employee Benefits survey of 510 employers. However, whether they are establishing, changing or evaluating matching contributions, it is important for employers to do so carefully to avoid unnecessary disruption for employees.

How Much to Match?

At its most basic, the decision of how much to match is a financial one. When employers offer a matching contribution, particularly when they couple it with automatic enrollment into the 401(k) plan, many employees will contribute at least enough to maximize the match. That is important to keep in mind when calculating the cost of any potential matching formula.

Beyond that, “employers should look at the revenue base line on their balance sheets over a historical time frame, such as the past four to six years,” said Deborah A. Castellani, principal and senior strategist at OTB Strategic Consulting, Inc. in Austin, Texas.

By identifying both the percentage of pay that will be eligible for the match (for example, 3 percent or 6 percent of pay) and the amount of the match itself (for example, a 100 percent dollar-for-dollar match, a 25 percent match or something in between), employers can calculate how much the match might cost under various scenarios. “This number will let the employer know what impact the match will have on its bottom line and if that level of match is sustainable,” said Castellani. (For a sampling of the wide variety of matching formulas, see the SHRM Online article 401(k) Match: Thresholds Drive Participation More than Rates.)

Sustainability is a key question for employers. Even if they can manage the match now, what will happen if the organization does not meet its revenue, growth or profitability projections in the future? “You should calculate forward carefully based on your growth rate and profitability to be sure you can afford to continue the match once you implement it,” said Kathy Boyle, president of Chapin Hill Advisors Inc. in New York City.

Other Variables to Consider

Obviously, the question of how much an organization can afford is a critical one but it is not the only question employers should be asking. A number of other variables can affect both the cost of a match and its effectiveness, including the following:

Nondiscrimination testing. If keeping key employees happy is an issue, employers should consider how much a given match formula will allow highly compensated employees to contribute to the plan under nondiscrimination testing requirements. The right match could increase plan participation enough among non-highly compensated employees and allow the highly compensated to contribute more to the plan. “You want to look at how much of the match will go towards owners and key employees and the after-tax cost,” said Boyle. (For a further look at matching formulas and nondiscrimination testing, see the SHRM Online article 10 Steps If Your 401(k) Plan Fails Nondiscrimination Testing.)

Frequency. The cost of the match can also be influenced by how frequently the employer deposits those matching contributions in employees’ accounts—each pay period, monthly, quarterly, annually or some other frequency. Lately, any changes that delay the frequency of matching contributions, such as monthly to annually, have drawn more negative headlines than cutting or eliminating matching contributions, as companies like IBM and AOL learned when they moved to a year-end match (see the SHRM Online article Learn from AOL’s 401(k) Missteps).

Eligibility limits. Vesting periods and other limits on eligibility can lower the cost of a match. Beware, however, of federal regulations that set limits on the maximum length of vesting for employer contributions—100 percent vesting after three years, or graduated vesting at 20 percent a year starting at two years until the employee is fully vested after six years.

Employers can also opt for faster vesting to take advantage of the safe harbor 401(k) plan design, which allows employers to forgo nondiscrimination testing. The safe harbor requires employers to make a minimum contribution to employees’ accounts or to match employee contributions at a certain level with all of these contributions vesting immediately (see the SHRM Online article Automatic Enrollment 'Safe Harbor' 401(k)s: An Exemption from Compliance Testing).

Industry-wide and organization-specific issues can also impact the decisions employers make when it comes to 401(k) plan vesting and eligibility. For example, an employer that operates in an industry with low tenure and high employee turnover, such as those in the restaurant and hospitality industries, might have good reason to delay employer contributions. If their employees were immediately eligible for plan participation and fully vested in employer contributions right away, that type of design could cost the employer a lot of money without generating much benefit.

This is also “one reason you don’t tend to see automatic enrollment as prevalent in the hospitality industries as they have low voluntary participation rates and automatic enrollment would have a dramatic cost impact,” said Alan H. Vorchheimer, principal in the retirement wealth practice at Buck Consultants LLC.

However, retirement consultant Rob McCracken, in an article for Pension Consultants Inc. (summarized online at the BenefitsPro website), observes that the overall trend is to scale back or reduce any barriers to retirement plan entry for employees. Citing SHRM research, he notes that plans offering immediate eligibility have increased from 45 percent of defined contribution plans in 2001 to 76 percent in 2013.

McCracken also points to data that indicates most employees switch jobs every 4.6 years. “Given these averages, over a 30-year period an individual would be losing out on seven-plus years of contributions into various employer-sponsored retirement plans if each employer had an eligibility waiting period of one year,” he writes.

In other words, using longer vesting periods to reduce employer costs might undercut the ability of the defined contribution plan to help typical workers save sufficiently for a secure retirement.

Engagement factors. Less easily quantified variables affecting the size and design of 401(k) matches include the employee goodwill the match generates, and reduced turnover that results from a match perceived as generous.

Making a Change

If an employer decides to reduce or change its matching contributions, it needs to handle that change with care. From a legal and fiduciary standpoint, changing the match is a straightforward matter of revising the plan document. “You would have to have your plan document amended, then communicate the change clearly to employees,” said Boyle.

However, managing the reaction to the change is not always so easy and straightforward. “The match is incredibly visible and easily understood by the average employee, especially when compared to something like medical plan caps on out-of-pocket costs,” said Vorchheimer. “The latter may change every year and may actually have a bigger impact on employees, but the match formula is just so simple.”

For that reason, “it is best for employers to look at their bottom line and find a match they can sustain and stay with it,” said Castellani. “Changing it may be easy, but it is also difficult both when it comes to the reactions of both participants and the public.”

If an employer has concerns that the organization’s financials will not support ongoing matching contributions, there are alternatives. Employers can choose to make discretionary contributions to the plan that do not have be repeated every year or to add a profit-sharing component. Although these types of contributions are unlikely to spur greater employee participation and deferrals, they allow employers that are unwilling or unable to commit to a regular match to contribute to the plan on employees’ behalf whenever they can.

Joanne Sammer is a New Jersey-based business and financial writer.​