Although employer matching formulas are designed to incentivize retirement savings, new research from Vanguard suggests that they often only have small effects on plan participation and employees’ saving, and can create a larger wealth and savings gap among workers. 

Vanguard’s data revealed that in two-thirds of plans, employer contributions exacerbate pay inequity, with 44% of dollars accruing to the top 20% of earners.  

“What we’re trying to do is bring attention to these very precious dollars and think about who’s getting them and are they causing people to save more,” says Fiona Greig, global head of investor research and policy at Vanguard. “A lot of plan features kind of play a role in that, but right now they’re not necessarily promoting equity and they’re also not necessarily encouraging people to save more.” 

It is not surprising that a greater share of employer matching contributions goes toward the top earners, given that matching contributions are often awarded as a proportion of salary. For instance, a 50% match on 6% of pay will be a significantly higher amount for someone who makes $100,000 a year compared to someone who makes $50,000 a year. 

In addition, Vanguard found that earners in the top 20% receive an 11% larger share of employer contributions than workers’ benefit-eligible income, while those on the bottom of the pay scale receive a 29% smaller share of matching dollars than income. 

Greig, says after assessing the equity of the 10 most common match formulas, the only formula that appears to reduce inequity is a dollar cap.  

Dollar-cap formulas, used in only 4% of plans, allow for employer contributions subject to a dollar cap that is below the maximum contribution limits per statute. For example, a plan may offer a 10% match on 6% of pay, subject to a dollar cap of $6,000.  

“In these kinds of plans, you’re not limiting your contribution, as an employer, based on income level,” Greig explains. “[You’re] limiting it based on a dollar value that applies to everybody.” 

According to the research, the top earners in plans with dollar caps receive, on average, a 6% smaller share of employer contributions than compensation.  

Greig adds that a company’s match formula also interacts with other plan-design features, so creating a more “equitable plan design” requires plan sponsors to assess all the features they offer.  

The Vanguard data showed that the next most equitable match formula, after the dollar cap, was a 100% match on 1% and 50% match on 6%.  

“This isn’t the most generous formula, and it’s also two-tier, so it’s kind of confusing,” Greig says. “But what’s neat about this formula is that it’s a safe harbor design that requires auto enrollment.” 

Essentially, the auto enrollment feature causes everyone in the plan to participate and allows the majority of workers to benefit from some match, even if they are not completely maxing out at 6%.  

“There are a bunch of other plan features that we think play a role in determining who gets the match, [such as] auto enrollment, immediate eligibility, immediate vesting [and] setting the default contribution rate equal to the maximum match,” Greig says. 

However, Greig points out that if a plan sponsor turns all of these features on, it could drive up plan costs. She says a strategy for a sponsor could be to offer a dollar cap match, thereby spending less on matching contributions and helping to pay for some of the other features. According to the report, dollar caps cost the least out of all match formulas because they limit the extent to which the match subsidy flows to those with the highest earnings. 

If an employee contributes 10% of her salary to her 401(k) plan, for example, and the company match is set at 6% of pay, the match is not creating an incentive for this employee to increase her contribution rate because employee contributions above 6% will not earn additional matching dollars. It is also unlikely that this employee is choosing to contribute 10% because of the 6% match.  

Vanguard found that most employer dollars (59%) are allocated to employees who are contributing above the match cap, which Greig argues is not an efficient or equitable way to use employer dollars. 

For lower-income participants, many are not participating in the plan despite the match. Less than 20% of workers contribute exactly at the maximum match, Vanguard concluded. 

The report suggests that there may be a cost-neutral way for employers to achieve greater equity and savings by making the match formula generous for some, and using the savings to pay for interventions that ensure greater participation and savings for others. 

No single formula is a clear winner, Greig says, as every employer has different objectives and goals. Dollar caps, for example, could help create better pay equity, but a drawback is that they may limit high-income earners’ ability to maximize their tax benefits and may reduce their total compensation. 

Vanguard also points out that policymakers play a role in promoting equity and efficiency, as many common match formulas, including safe harbor designs, disproportionately benefit higher-income employees.  

“But even without any policy change, there’s a lot that employers can do to promote equity,” she says. “Plan design matters a lot and can be an equalizing force in terms of [leveling] the playing field, causing more lower-income workers to participate in saving in the plan and benefiting from the match.”