I was reminded of the issue of year-end 401(k) matching by employers when I learned that the employer of a close relative was changing their match to the end of the year.
A few years ago, AOL announced that they were moving to a year-end once per year match on their 401(k) plan. AOL subsequently rescinded this change due to the public relations disaster caused by the firm’s Chairman tying this change to both Obama Care and specifically to two high-risk million dollar births covered by the company’s health insurance in 2012. Many major companies, including IBM, have gone this route in recent years. What are the implications of a year-end annual 401(k) match for employees and employers?
Implications for employees
Ron Lieber wrote an excellent piece in the New York Times entitled Beware the End-of-Year 401(k) Match about this topic. According to Lieber:
“AOL’s chief executive, Tim Armstrong, drew plenty of attention earlier this month when he seemed to attribute a change in the company’s 401(k) plan in part to a couple of employees whose infants required expensive care. But what was mostly lost in the discussion was just how much it would cost employees if every employer tried to do what AOL did.
The answer? Close to $50,000 in today’s dollars by the time they retired, according to calculations that the 401(k) and mutual fund giant Vanguard made this week. That buys a lot of trips to see the grandchildren — or scores of nights in a nursing home.”
The Vanguard study assumes an employee earns $40,000 per year and contributes 10% of their salary for 40 years, the investments earn 4% after inflation and the employee receives a 1% salary increase per year. The worker would have a balance that was 8.7% lower with annual matching than with a per pay period match. Of note, the Vanguard analysis assumes that this hypothetical worker missed 7 years’ worth of annual matches due to job changes over the course of his/her career.
Lieber also discussed the case of IBM’s move to year-end matching that also proved controversial. IBM, however, offers all employees free financial planning help and has a generous percentage match.
Additional implications of an annual match from the employee’s viewpoint:
- One of the benefits of regular contributions to a 401(k) plan is the ability to dollar cost average. The participants lose this benefit for the employer match.
- Generally, employees must be employed by the company as of a certain date in order to receive their annual match. Employees who are looking to change employers will be impacted as will employees who are being laid off by the company.
- If the annual match is perceived as less generous it might discourage some lower compensated workers from participating in the plan. This could lead to the plan not passing its annual non-discrimination testing, which could lead to restrictions on the amounts that some employees are allowed to contribute to the plan.
Note employers are not obligated to provide a matching contribution. The above does not refer to the annual discretionary profit sharing contribution that some companies make based on the company’s profitability or other metrics. Lastly to be clear, companies going this route are not breaking any laws or rules.
Implications for employers
I once asked a VP of Human Resources why they chose a particular 401(k) provider. His response was that this provider’s well-known and respected name was a tool in attracting and retaining the type of employees this company was seeking.
While not all employers offer a retirement plan, many that do cite their 401(k) plan as a tool to attract and retain good employees.
There are, however, some valid reasons why a plan sponsor might want to go the annual matching route:
- Lower administration costs (conceivably) from only having to account for and allocate one annual matching contribution vs. having to do this every pay period. In many plans the cost of administration is born by the employees and comes out of plan assets, in other plans the employer might pay some or all of this cost in hard dollars from company assets.
- Cost savings realized by not having to match the contributions of employees who have left the company prior to year-end or the date of required employment in order to receive the match.
- Let’s face it the cost of providing employee benefits continues to increase. Companies are in business to make money. At some point something may have to give. While I’m not a fan of these annual matches, going this route is better for employees than eliminating the match altogether.
Reasons a company wouldn’t want to go this route:
- In many industries, and in certain types of positions across various industries, skilled workers are scarce. Annual matching can be perceived as a cut in benefits and likely won’t help companies attract and retain the types of employees they are seeking.
- Companies want to help their employees to retire at some point because they feel this is the right thing to do. Additionally, if too many older employees don’t feel they can retire this creates issues surrounding younger employees the company wants to develop and advance for the future.
Overall I’m not a fan of these annual matches simply because it is tough enough for employees to save enough for their retirement under the defined contribution environment that has emerged over the past 25 years or so. The year-end or annual match makes it just that much tougher on employees, which is not a good thing.
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I agree with you. Technology is an ever so changing industry where employee retention is very important. Probably not enough for someone to leave the company but it’s something that counts against AOL. Definitely a tough call to make.
Thanks for your comment Michael. I think this goes beyond the AOL situation. This is not a major trend as of yet, but as overall employee benefit costs continue to increase this could become a way for employers to save some money.
8.7%? It would appear the monthly deposit method averages a 6 month head start from the year-end deposit. So the hit to the employees is about half whatever Vanguard wishes to use for average returns. 8.7% seems closer to a full year.
Joe thanks for the comment, realized that I had not included the assumption that VG made that this hypothetical worker missed 7 or 40 annual matches due to job changes over his/her career. I edited the post to include this.
Hi Roger:
Two things to note. First, this bad for employees who leave AOL. Over the course of a 20 year career, I don’t think it has a huge impact on one’s balance. I calculated the impact of the switch (assuming 8% returns, $11 MM AOL Contribution and 4,801 employees) at $85.90 per plan participant.
Most companies design plans to reward long term employees.
Second, as a recordkeeper, it is much easier to do the matching on a pay-period basis than at year end.
@tomob
Tom thanks for your comment. I think this is a complex issue and one that will not go away as overall employee benefit costs continue to increase. Not withstanding Mr. Armstrong’s ill-conceived remarks there are some valid points on both side of this issue from the perspective of plan sponsors and plan participants. It will be interesting to see if more sponsors go this route in the future.
Good, balanced post Roger. I only see more of this trend continuing as it generally makes too much sense for the employer, especially if you’re looking at it from a cost perspective. The shame in all of this, assuming it does continue, is that it just makes it more difficult for those wanting/needing to put away more for retirement to do so due to the loss of some of the benefits of per pay period matching. Like you pointed out, another issue is if an employee changes employers in the middle of the year. I’ve been reading about concerns of what that could potentially do with vesting issues. It’s definitely an interesting time to see what’ll unfold.
John thanks for your comment and I agree with the points you made. Its a tough issue and as an advisor to both organizations that sponsor these plans and to individual investors I can see both sides.
As an investor, I am concerned that I get all the money dumped in one quarter. I believe in theory that in the final quarter, stock prices are at their highest (or lowest), thus you have lost the averaging over the year. On the other hand, I track in Quicken and boy does it love to constantly ask you to enter missing transactions and prices to get an accurate reflection of performance.. Once a year then becomes easier tracking in Quicken.
Scott thanks for your comment. I’m not sure about the highest/lowest part but I agree that this takes away the benefits of dollar cost averaging over the year.
It is January 2018. I am an RN and my employer who is a very large Hospital and Healthcare provider has decided to do year end match as and “incentive” to keep people. I am afraid the effect will be the opposite. I planned on staying with this employer til I retire, but now must reconsider as my former 8% biweekly match has ended. With my years of service I had worked up to this point of benefit and it has now been taken from me. In 2017 I earned over 20% on my match, and had the advantage of dollar cost averaging. Not only is this bad for me, but the market no longer gets a regular influx of capital to work with. This year end match greatly increases my risk and will be a negative incentive to stay with this company.
Thanks for your comment Dave and sorry that this happened. I agree that this is actually a disincentive to stay with an employer in many cases. My understanding is that nurses and some other healthcare employers are tough to find, odd that their benefits and HR dept would adopt this. Perhaps the real reason is that they don’t want to be on the hook for the match for employees who ultimately do end up leaving prior to the time of the match.
I believe it is just greed and a lack of appreciation to the people who are the face of the corporation.
Sadly I think that you are right in many cases Dave.
I work for a company that matches 401K at the end of each year. This year they will be selling out to another company between July and September. Is my current employer obligated to match the 401K up to the point of sale? Thank you.
Thanks for your comment Mike. Here is a good summary of what some of the options are when a company is merged or acquired, but no mention of the year-end match. I honestly don’t know the answer to your question. Depending upon how comfortable you feel doing so, this is a good question to ask the benefits folks at your current employer or the new company once the acquisition goes through. Good luck. http://www.401khelpcenter.com/401k_education/corporate_merger_and_your_401k.html#.Wu4qiaQvypo