Benefits December 2, 2024

The Mechanics of Matching

Employers are reconsidering the most important factors in setting their workers up for savings success.

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Art by Nadja Zinnecker

This story has been updated for the magazine. That version can be found here: “The Power of the Default Rate”

Some employees will be urged to keep their savings on track in 2025 to avoid potentially missing out on $300,000 in retirement wealth. That’s what Vanguard’s research looking into so-called “savings frictions” estimated as the amount a worker may lose through job changes. It can happen when workers are defaulted to a lower deferral rate at a new company’s 401(k) plan, rather than carrying over higher contribution levels from their prior jobs.

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“All of these defaults that allow the savings to happen more on auto-pilot have been really, really great, but what we are focused on is the next generation, or next frontier, of plan design, where we can see there are some inefficiencies or what we call, ‘savings friction,’” says Kelly Hahn, Vanguard’s head of retirement research, based out of Malvern, Pennsylvania. Vanguard is developing an effort to engage new retirement plan joiners on its platform to carry over their prior savings rates when they change jobs in 2025 so as not to lose that savings momentum.

For many researchers and consultants, employer contribution strategies are getting a rethink. They see tweaking automatic-enrollment strategies, reviewing default rates and communicating with employees as paying big dividends in improving retirement planning and readiness.

Hahn’s research showed that the frequency at which people change jobs, with a median tenure of about five years, has a lasting effect on overall savings. The findings demonstrated that savings rates drop largely due to default rates and automatic features that do not align from employer to employer.

As an example, with the most commonly used plan features—typically a default rate of 3% salary deferral, with automatic increases of 1 percentage point up to a 10% cap—a person with a five-year tenure would achieve an 8% savings rate. But when that individual changes jobs, if the new employer defaults to 3% and the employee does not choose to increase the savings rate, there is an immediate savings reduction of 5 percentage points, she says.

“We need to be smarter about improving the auto features even more to help people maintain their savings,” she says. “When we saw the results, they were intuitive, because it makes sense that many people are unengaged, and they follow the auto features that have already been implemented by their employers, so when you look at it from that angle, it’s not so surprising. But what was surprising was the magnitude of the reduction and how often it can happen to a participant.”

Default Rates’ Significance

David Blanchett, head of retirement research at PGIM DC Solutions, also finds that the default rate has the biggest impact on retirement savings and has even more bearing on success than a company match.

“The match is important, but what is most important is default savings rates,” says Blanchett, based in Lexington, Kentucky. By his calculations, plan sponsors should boost the default savings rate substantially: “6% is the new 3%.”

Lower default rates may also, unintentionally, signal sufficient savings to some employees, Blanchett’s research finds. His examination of about 157,000 plan participants who had recently enrolled in a 401(k) plan, showed that plans with the lowest savings rates offered both low default and low match of 5.7%. Savings rates increased by about 1.58 percentage points for plans that defaulted to a higher savings rate , according to his research.

Considering that plan sponsors have different goals and may be concerned about the cost of matching if defaults are increased, Blanchett recommends simply reducing the match.

Employers’ ‘Very, Very Important Role’

Vanguard is also encouraging plan sponsors and consultants to consider setting higher default savings rates of around 6%, since at that rate, the slowdown in savings rate is minimal, Hahn says.

There is also a push to automatically enroll, for anyone who has not already adopted that feature, according to Hahn. (Only about 60% of plan sponsors on Vanguard’s recordkeeping platform auto-enroll, she says.)

Finally, she urges plan sponsors and consultants to nudge their participants to transport their prior retirement savings rates to their new company to maintain what she calls “savings momentum.” Hahn also recommends that plan sponsors and consultants use an employer match to help workers save between 12% to 15% of their salaries.

“The employer match is going to vary, depending on the industry, as a retention tool or talent acquisition tool,” she says. “We want workers to think about total savings rate, and employers have a very, very important role to play in that.”

Michael Kreps, a principal in Groom Law Group, based in Washington, D.C., also sees the benefit for some employers, concerned about rising expenses, in increasing the default rate but decreasing the match.

“It doesn’t have to change your costs at all, because nobody has to do a match,” Kreps says. “Congress has gotten more and more comfortable with auto-enrollment and with other types of auto features. You don’t have to match—it doesn’t really have to impact cost much at all.”

What Will SECURE Provisions’ Uptake Be?

Automatic enrollment is another matter, however, and new plans will be mandated to auto-enroll all employees, starting in the new year. While there was always some concern about auto-enrollment from an employer perspective, since it could potentially increase costs, Kreps says he anticipates those will be offset by tax credits for small employers.

In addition, absent federal rules, many states, such as California, already require employers to auto-enroll employees, which has provided a road map for others. As a way to boost overall financial health, Kreps says he is also watching the adoption of a potentially promising option authorized by the SECURE 2.0 Act of 2022 for employers to match employees’ student loan repayments.

“Of all the SECURE and SECURE 2.0 provisions, this is one of the ones that employers are most interested in,” Kreps says. “They understand, correctly, that people are under a lot of financial pressure, and they want to do something to alleviate at least some of that.”

Benefits December 2, 2024

Behind the 401(k) Match: Why Employers Offer It and How to Best Design It

Implementing an effective employer contribution strategy requires plan sponsors to consider timing, costs and the workforce’s specific financial needs.

Reported by
Art by Nadja Zinnecker

This story has been updated for the magazine. That version can be found here: “To Cultivate the Best Match”

Offering a matching contribution toward workers’ retirement savings has become table stakes for most employers, as it is a key benefit to attract and retain talent in a competitive job market.

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But designing a match formula that best suits an employer’s specific population, as well as deciding on the timing of contributions, are key considerations when implementing an effective contribution strategy.

Value of the Match

Holly Tardif, director of retirement at Willis Towers Watson, says an employer contribution as a traditional match, as a nonelective contribution or as profit-sharing can be a “strong differentiator” between potential employers.

“The match is that valuable, consistent addition to [employees’] compensation, but also, in the current economic environment, it supports financial wellness,” Tardif says. “By matching contributions, employers can really help employees build more substantial retirement savings over time, which helps reduce financial stress and improve overall financial security. We know when employees are less concerned about their financial future, they’re more engaged and productive at work.”

Tardif adds that employees are more likely to feel valued and committed to a company if they see their employer actively supporting their financial goals.

For employers, offering a match also comes with tax benefits: In most cases, at least a portion of employer contributions to retirement plans is tax-deductible, so companies can use them to lower their overall tax burdens.

‘Timing is Everything’

The structure and timing of employer contributions is an important consideration that can ensure the match suits the unique culture of an organization. Employers take different approaches as to when they provide contributions—whether that be per pay period, quarterly or annually—and Tardif says, in this instance, “timing is everything.”

That is because different cost considerations come with each match structure. For example, Tardif says frequent contributions can sometimes drive up the employer cost, but they can also boost employee engagement, because workers can see the accumulation of their account balances on a more regular basis.

“Contributing each pay period creates that steady growth rhythm for employees, but for employers, it requires that consistent cash flow and increases the administrative expenses [due to] having to set up payroll and vendors to keep track of that process and calculate it each pay period,” Tardif says.

On the other hand, delaying contributions, such as making them on an annual basis, can help employers better manage their budgets. But Tardif says this could impact the perceived value of the match, as workers are not seeing the consistent, compounding impact of their savings.

A delayed match strategy could, however, be used for employee retention, as a longer vesting schedule could encourage workers to stay at the company until they receive their full match.

What Type of Match?

Deciding on the type of contribution to offer employees is also dependent on the needs of specific workforces and their financial vulnerabilities.

For instance, Tardif says some workers have to make trade-offs between saving for retirement and paying off student loans or a mortgage. She says this exemplifies the value in offering a nonelective contribution, because it allows employees to potentially save for other things outside of retirement, but still receive an employer contribution toward their 401(k) plan regardless.

At Bonfe Plumbing, Heating & Air Service Inc., a small business based in South St. Paul, Minnesota, employees are offered a generous package of retirement benefits. The company matches 100% of employee contributions, up to 5% of salary (which builds up to take effect in an employee’s fourth year), and also provides a 3% nonelective safe harbor contribution and eligible profit-sharing. Employees need to have worked at the company for at least two years to receive the nonelective contribution.

Matt Voecks, a retirement plan adviser at Pensionmark, which is owned by World Insurance Associates LLC, who works closely with Bonfe, says the nonelective contribution is the “meat” of Bonfe’s retirement benefit.

“The [nonelective contribution] is the largest monetary outlay that Bonfe would have,” Voecks says. “However, they add on top of that a meaningful matching contribution to ensure that people aren’t just sitting on their hands and not participating.”

Tardiff says she is seeing more employers considering adding a nonelective contribution to their plans, especially as participants are struggling to set money aside for retirement.

“In today’s environment, where we know people just have enormous financial stress and trouble making ends meet on a day-to-day basis, asking them to take 3%, 4% [or] 6% out of their salary and save it away 20, 30, 40 years down the road—that’s a hard ask of people,” Tardif says. “We’ve seen a lot of employers really taking a hard look at maybe adding a portion of a nonelective contribution or moving to a nonelective contribution altogether to help improve that financial resilience.”

Default Rate Is Key

In addition, Bonfe automatically enrolls participants at a 10% default rate and, according to Andy Nelson, a human resource manager at Bonfe, the majority of employees maintain that default rate and are appreciative that the responsibility of enrolling is out of their hands. The default was previously at 6%, and Nelson says the company never heard any complaints about it.

“We don’t want our employees leaving money on the table,” Nelson says. “If they’ve been happy with [the 6% default], we thought, ‘Why don’t we move it up to 10%, so they’re maxing out the benefit for themselves?’”

Voecks emphasizes that it is important for plan sponsors to lean into the concept of helping employees save enough to receive their full matching contribution. He adds that the automatic enrollment rate is essentially a reflection of what the employer recommends as an adequate rate for retirement savings—without the employer directly recommending it.

“If there’s one thing to convey to sponsors, it’s remembering their decisions for some of these auto features and matching contributions tie into their recommendations for their staff,” Voecks says. “If you auto-enroll at 3%, technically what you’re doing as an organization [is] recommending that people save at 3%, and that’s going to be adequate. And the reality is: It just isn’t.”

Fidelity Investments, for example, recommends working up to saving at least 15% of one’s pretax income each year for retirement, including any employer contributions.

When it comes to timing the matching contributions, Bonfe provides the employer contribution on a paycheck-to-paycheck basis. At year-end, the company also provides a true-up to ensure that if employees either front-loaded or back-loaded their contributions, they receive whatever matching contribution would have otherwise been owed.

Because Bonfe was previously sponsoring a union plan, the company runs weekly payrolls. While it is no longer a union plan, Nelson says Bonfe decided to keep the weekly payrolls so employees would not experience as much of a transition, and he believes it will keep them competitive as an employer.

Total Rewards Package

Nelson emphasizes his focus on offering benefits that help Bonfe remain competitive in the market and attract the best employees.

“At the end of the day, we’re still a small business,” Nelson says. “It’s not like we can have the resources that some of the huge businesses like Google have, but we also want to have the best employees. … In order to attract the best employees, we need to have the some of the best benefits.”

Outside of its 401(k) plan, Bonfe offers life insurance, employee assistance programs, access to virtual doctors and long-term disability insurance, among other considerations.

Tardif says employers should be thinking about their “total rewards package” to attract and retain talent. She also says it is important for employers to periodically reevaluate their match formula, especially if they have maintained the same contribution level for a long time.

“It’s about looking around and saying, ‘How do we modernize the match concept?’” Tardif says. “Now is a really good opportunity to dissect that a little bit and think about: What is the timing of allocations, [and] does that still meet [your] workforce needs?”

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