One Less Furrowed Brow For 401k Plan Sponsors
This blog will explore the important and often overlooked aspects of matching 401k plan contributions in order to help you, as a sponsor of the 401k plan, make optimal benefits decisions.
Each year at this time, organizations are scrambling to set their budgets for the coming year. As a sponsor of a 401(k) Plan for your employees, you want to make sure your 401(k) Plan is a top priority and that it provides appropriate benefits that match both your priorities and those of your workforce. You want to ensure that you’re not leaving money on the table by not matching employee contributions. Knowing how investors react when their investments do not return as much as they would like can be troublesome for many people. For others, it’s more worrisome to know how investors react when they make bad investment decisions. However, this is exactly what is at play when considering matching contributions.
In my experience working with a variety of 401k plan sponsors and reviewing their investment menus and 401k plan design years back in the day, I noticed that many of the plans were not making optimal matching contributions. Many were simply equal dollar for equal dollar match of “the first 6%” or “the first 7%” or “the first 8%” of participants’ contributions.
If you are a sponsor of a 401k plan, here’s what you need to know.
Understand the Match Calculation Formula
The formula most often used to calculate matching contributions is this: 1% x # of contributions + 1% x total investment gains. So for example, if an employee has contributed $2,000 per year (of which $1,000 was eligible to be matched), the maximum possible matching contribution would be $200 ($1,000 + 200). If an investment that is purchased simply outperforms its peers and increases in value by 10%, then your employees would end up with more money in their account than they would have with a non-matching contribution of $200. This brings up an important point that many people do not understand:
This formula does not actually take into consideration the performance of the investment portfolio. The investment portfolio is the “investment” that is being matched for. All investments are created equal, and allocating a maximum of $200 to each employee means that your employees will get less money at retirement if their account does not perform well than they would if you allocated exactly $200 to each employee.
Don’t Forget the Performance of the Portfolio
In order for matching contributions to be optimal, the investments that are included in your plan have to perform well. If your investment portfolio loses money but still outperforms their peers, then your employees may end up with more money at retirement than they would if you matched them with a dollar amount in a non-performing portfolio. Of course, as with many things in life, investing is not quite as simple as that. One of the main factors that determines how well a 401k plan performs is how diversified it is. In the 401k plan example above, if your employees’ investments were only allocated to very safe and well-performing investment options (such as a 100% stock mutual fund portfolio or index funds), then they would not get any gains at all. They would end up with exactly what they would have with a non-matching contribution of $200.
Matching Contributions For Advisors
Many 401k plan sponsors are concerned about matching contributions for their employees because of the potential for conflicts of interest. The matching contribution is a benefit to employees, so it is important that it be fair, transparent, and not cause misunderstandings or confusion. Therefore, when employers make matching contributions to their employees’ accounts, they are required to do so through a plan design that has no real investment risk to the employer. All 401k plans are required by law to have a fixed percentage of assets allocated towards certain low-risk investments such as stable value funds or money market funds. This ensures that the employer’s match will always be there at retirement.
To be clear, if you are an employee and you want to have your plan sponsor make matching contributions, you must ask them to do so. However, if your plan sponsor does not want to make matching contributions for any reason or is planning on continuing to match at a rate lower than it has in the past, encourage them to evaluate their investment menus and menus of options. If they need extra help developing a good 401k plan design or if they would like me to review their account menus for them, please contact me for assistance. I can review your current menu and help you come up with an account menu that is as efficient as possible.
If you are an employee who would like to learn more about the pros and cons of matching contributions, please contact me. I can provide you with a free evaluation of your plan and discuss the benefits and consequences of matching contributions in more detail.
In summary, theoretically, if two identical investors performed exactly the same returns over a given period of time (up or down) but one got no benefit from his investments at all because his employer was not making matching contributions, then he would end up with more money at retirement than the other investor. For these reasons (among many others), it is very important to match your employees’ 401k contributions as much as possible. Remember, every employee wants to be treated equally. Make sure that they get the same benefits from the plan as everyone else.
Matching contributions are in your plan. Maximize them!
This information is provided for educational purposes only and does not constitute investment, tax or legal advice. Before deciding on any course of action, including but not limited to those involving the purchase of a particular security or investment strategy, you should consult a qualified financial advisor. All investing involves risk including loss of principal and opportunity cost so consult with competent professional advisors before you make any investment decisions.
Conclusion
There are some important things to keep in mind before deciding whether to match your employees’ 401k contributions. First and foremost, make sure you have an effective profit sharing plan design. Do not just match the employees’ contributions and forget about good plan design. Make sure you allocate a minimum percentage of participant assets for low-risk investments such as stable value funds or money market funds so your matching contributions will be there at retirement. Matching contributions are great for employees, but they can cause problems for employers if they are not handled properly.
If you would like to learn more about matching contributions or have any questions for me, please contact me.