A few weeks ago a friend and I were talking about retirement and our 401k plans. His company had recently changed their retirement plan and he’s been reviewing the paperwork for his new 401k.
As he read through his new employee handbook, it seemed to insinuate that his employer would match his contribution just once a year. Clearly irritated, he asked me “Is that even legal?” I’ve spoken before about the importance of making sure folks get their full match. This change to his plan certainly wasn’t encouraging him to save, but it is legal.
Typically, as you contribute to your 401k from your paycheck, your employer match is deposited with your contribution. The two contributions then enjoy the benefits of dollar-cost averaging together. See here for a refresher on the benefits of dollar cost averaging. The plan my friend now has changes the contribution rules completely.
Here are the differences:
• Contribution is made as a one-time lump sum
• Timing of the lump sum is at the companies discretion
• If an employee leaves work for any reason, by their choice or their employers, the employee will receive no match. The match is NOT prorated.
The last bullet point is where most frustration lies. In theory you would work for 364 days of a year, get laid off on the last day and you will receive no match for that year.
401k plans such as these take the “match” aspect out of employee’s contributions, and align it more with an annual bonus type structure. In my opinion, it removes a key incentive to encourage employees to save for retirement, and instead makes it more of an employee retention tool, which is frustrating.
A disturbing trend?
Two recent retirement plan studies show that 401k’s with an annual match are so far a minority. Surveys from the past few years show adoption of plans like these range between 8-11%, and most of those plans are the older variety that never adopted the traditional paycheck 401k match. Charles Schwab, for example, has had an annual match since first rolling out their 401k.
IBM switched to an annual match program in 2012. Due to the size of the company and the number of employees, the move garnered much attention, including that from a few United States Senators who wrote to the company trying to stop the change. IBM chose to ignore the outcries and made the switch regardless. In IBM’s defense, they do offer a higher than average match, and they also offer employees access to a financial planner so that employees can get advice one-on-one.
Many were concerned at the time that a shift to an annual match from such a large and household name like IBM would lead to other companies following suit. That has yet to materialize, although AOL tried last year to adopt the same measures. AOL’s proposal was met with huge resistance from employees, who then took the media outlets for support. AOL ultimately reversed its decision and continues to match 401k contributions in the traditional manner. Kudos to the AOL employees on behalf of the rest of us, because by taking the fight to the media and winning, perhaps other companies have changed their mind about making such a move.
What you can do if you have a plan with annual match
If your employer does annual 401k matches there may not be much you can do about changing it. Certainly complaining to your HR department would be one suggestion. In fact, folks working in your HR department should be on your side as they themselves are only receiving the annual match.
For couples who find it hard to save enough every year, you may want to review the plan details for your spouse. I met a couple once who were both saving the identical same 5% from their paychecks. They were doing themselves a disservice however, as the husband’s plan only matched the first 3% while the wife’s plan matched up to 6%. You will need to crunch some numbers, and consider your salaries, as that will determine the nominal difference you might benefit from by overloading one spouse’s plan against another.
We find that typically folks who save in a ROTH or Traditional IRA wait and make a lump sum contribution during tax time. We encourage these folks to switch to a monthly contribution amount, to mitigate some of the effect of the annual 401k match.
Finally, if you have one of these plans we strongly urge folks to review their 401k plan for how contributions are allocated in your account. Since the lump sum could be substantial, the addition of new money could throw off your overall allocation depending on how new money is allocated. We’ve seen folks who forgot that new money was being allocated only to a money market account, and there it sat until the person finally reviewed their portfolio and caught the error.
While 401k plans that have an annual match aren’t an ideal situation for employees, it’s key to remember that saving is your primary goal. Don’t let the timing of the company’s match dissuade you from saving in your plan. 401k plans are a great tool that we have at our disposal and don’t let your frustration lead you to choosing not to contribute!
The information contained in this post is not intended as investment, tax or legal advice. StrategicPoint Investment Advisors assumes no responsibility for any action or inaction resulting from the contents herein. Derek’s opinions and comments expressed on this site are his own and may not accurately reflect those of the firm. Third party content does not reflect the view of the firm and is not reviewed for completeness or accuracy. It is provided for ease of reference.