Employer contributions to defined contribution (DC) plans are very common. In Vanguard’s survey of their recordkeeping clients, “How America Saves 2015,” 94% of the plans provided employer contributions. Forty-six percent provided only matching contributions and 37% provided both matching and non-matching contributions. Matching contributions provide added incentive for employees to participate in the plan. Typically these are structured such that the employer will provide a matching contribution at a stated percentage of an employee’s contribution with an overall cap. For example, the employer matching contribution might be 50% of the employee’s contribution up to a maximum of 3% of their annual compensation.
A rational response to matching contributions is for employees to make contributions up to the maximum amount for which they would receive an employer match. However, if the match cap is set at a rather low level of contributions, then the combined savings rate for the employee who elects to contribute only to the match cap may be insufficient to provide for a financially secure retirement. For example, if the match cap is 3%, then employees investing only up to the employer match would fall short of the 10% goal of annual compensation, a minimum savings toward retirement that is commonly recommended by retirement consultants.
The “expected” behavior of participants provides the employer with an opportunity to help increase savings rates. Increasing the match threshold should encourage participants to increase their contributions and thus achieve higher savings. In assessing the consequences of the employer match, plan sponsors may want to reduce the matching percentage and increase the cap to see if the savings rate would increase without negatively impacting the participation rate. For example, a plan that currently provides a 100% match up to 3% of compensation could change to a match of 50% up to 6% of compensation. The intended effect would be that participants would increase their contribution rate to the minimum to take full advantage of the match, thus also saving more of their annual income and getting closer to reaching the 10% savings goal. Before making a change, plan sponsors should evaluate the facts and circumstances of their organization’s plan and monitor the impact of any such changes to ensure that savings goals are being achieved.
In our last two articles, we addressed tactical initiatives that plan sponsors could utilize to help increase employee participation and savings in DC plans. These included automatic enrollment to increase participation rates and automatic escalation to boost savings rates. Tailoring the matching contribution to maximize participant contribution rates is another useful plan design feature. There are many other plan design features that can be utilized to help DC plans improve participants’ retirement outcomes, including participant education and an offering of investment option menus. These are topics that will be explored as we continue to address how plan sponsors can optimize their DC plans to help participants reach a successful retirement outcome.
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