401(K) Plan Match Formulas and Automatic Features Add Value for Participants
Generous matching contributions to 401(k) or similar plans can be an effective recruiting and retention tool, increasing employees’ total compensation and helping them to build their retirement savings. Choosing appropriate automatic enrollment and auto-increase plan defaults can also help employees build retirement security.
New reports from retirement plan service providers give a snapshot of average, and above-average, plan features, which can help employers see how their retirement plans might look to job candidates.
“To help employees understand the value of employer retirement contributions, present them as part of the total compensation the employee receives,” advised Fidelity Investments. “It’s money they receive today to help them live well in the future.”
Advisory firm XpertHR’s 2021 Employee Benefits Survey found that among the 271 surveyed employers that offered a traditional 401(k) plan, 82 percent matched at least some portion of employee contributions to the plan, compared with 18 percent that provide no matching funds. The survey was conducted from March 30 to April 23 among employers of various industries and sizes.
According to investment firm T. Rowe Price, the top five employer-match formulas used by defined contribution plans last year were:
- 50 percent up to 5 percent of pay (20 percent of plans).
- 100 percent up to 3 percent of pay + 50 percent up to the next 2 percent of pay (19 percent).
- 100 percent up to 4 percent of pay (12 percent).
- 100 percent up to 6 percent of pay (11 percent).
- 100 percent up to 5 percent of pay (9 percent).
The findings are from Price’s Reference Point benchmarking report, based on data from 674 plans for which the firm provided a full range of services last year.
Fidelity Investments’ Employer Contribution Trends report for 2020 has similar results, finding that the most common matching formulas, based on 7,506 corporate defined contribution plans offering employer matches, were:
- 100 percent match on 3 percent of pay + 50 percent on the next 2 percent of pay (41 percent of plans).
- 100 percent match on 4 percent of pay (15 percent).
- 50 percent match on 6 percent of pay (8 percent).
- 100 percent match on 5 percent of pay (6 percent).
- 100 percent match on 6 percent of pay (7 percent).
Among the 1,700 employer-sponsored plans for which investment firm Vanguard provided record-keeping services last year, the firm’s How America Saves 2021 report disclosed that:
- 50 percent of Vanguard plans provided contributions through an employer match.
- 36 percent provided both employer matching and non-matching (discretionary) contributions.
- 10 percent provided only profit-sharing or other discretionary contributions.
- 4 percent made no employer contribution.
In addition, the firm reported that most plans promised a match of between 3 percent and 6 percent of pay; the average value of the promised match was 4.5 percent of pay. Vanguard’s report didn’t provide a breakdown of match formulas.
Some plan sponsors employ “stretch the match” formulas, requiring that employees contribute a higher percentage of their pay to receive the full employer match. For example, rather than provide a 100 percent match on an employee’s contribution of 4 percent of pay, the employer would match 50 percent up to a contribution of 8 percent of pay.
Fidelity found that “stretching the employer match formula can encourage higher savings rates among employees, helping them to save at necessary levels to be retirement ready.”
Vanguard, however, said its research has found that higher match thresholds were typically associated with lower plan participation and lower employee contribution rates.
Whether stretch matches will raise or lower savings rates at an organization may depend on different workforce demographics—for example, how much the average worker earns and whether employees have sufficient discretionary income to increase their default contributions.
While 7 in 10 Vanguard plans allow employees to make voluntary contributions immediately after their hire date, employers often delay letting employees vest in matching funds and other employer contributions.
“A one-year eligibility rule is more common for employer contributions, presumably because employers want to minimize compensation costs for short-tenured employees,” Vanguard reported.
XpertHR found that among the 222 responding companies that provide matching funds, 28 percent fully vest their employees in these funds immediately, while most require a waiting period.
“While employers often provide matching funds for their traditional 401(k) plans, most require wait times—sometimes up to several years—for employees to become fully vested in those employer contributions,” noted XpertHR survey editor Andrew Hellwege.
These waiting periods to vest in employer matching contributions vary, and respondents noted several time frames of up to six years, with the top three vesting periods being:
- Up to five years (17 percent of plans).
- Up to three years (14 percent).
- Up to one year (13 percent).
At year-end 2020, 54 percent of Vanguard plans had adopted automatic enrollment, and that figure was higher—74 percent—for plans with at least 1,000 participants.
Two-thirds of automatic enrollment plans have implemented automatic annual deferral rate increases. Additionally, auto-enrollment defaults have increased over the past decade: 57 percent of plans now default employees at a deferral rate of 4 percent or higher, compared with 30 percent of plans in 2011, Vanguard reported.
An overwhelming 98 percent of plans chose a target-date fund as the default investment.
T. Rowe Price reported that last year among the plans for which it provides services:
- 81 percent had adopted auto-enrollment, up from 69 percent in 2015.
- 62 percent automatically increase participants’ deferral rates each year unless the participant opts out, up from 51 percent in 2015.
- 36 percent used an auto-enrollment rate of 6 percent of pay or higher, while 30 percent had a 3 percent default rate.
Among Fidelity’s auto-enrollment plans, 48 percent of employers were using a 4 percent auto-default rate, and 42 percent were using a 3 percent rate.
Automatic Contribution Increases
Annual automated deferral increases resulted in participants saving 20 percent to 30 percent more after three years than employees without automatic increases, Vanguard found. Among plans with an automatic increase feature, the most common auto-increase rate for employee contributions is an additional 1 percent of pay each year, used by 67 percent of plans.
The largest group of employers, 46 percent, stop automatic increases when an employee’s annual contribution rate reaches 10 percent of the employee’s pay, Vanguard reported. However, 26 percent cap auto-increases when contributions reach 11 percent to 20 percent of pay, while 13 percent use a cap of 6 percent of pay. Five percent of plans had no cap on automatic increases.
Staying the Course
According to T. Rowe Price, employees’ average contribution rate for 401(k) or similar plans ticked up from 7.6 percent of pay to 7.8 percent last year. That slight improvement during a challenging year “could be connected to several factors, including plans adopting auto-increase, increasing the match ceiling, and perhaps a participant population better educated in financial wellness and the benefits of saving for retirement,” the firm noted.
At the end of last year, higher savings rates “combined with the fact that the majority of participants did not react to the market volatility by making withdrawals from their accounts, contributed to the overall average balance increasing by 13 percent over 2019,” Price reported.