Chepeni(k)’s Thoughts: Employer Matching Contributions Not a Panacea

The word lagniappe reminds me that, for years, we have been telling employees to save enough in their employer-sponsored retirement plans to receive the maximum match – that “little something extra” meant to thank them for their hard work and provide a few additional dollars for their retirement.

I realize now I have been teaching the wrong message.

Here’s where I, and the industry, made our mistake: we touted the employer match as “free money,” and therefore, convinced employees that saving enough in their company retirement plan to receive the match was “good enough.” But it wasn’t. We failed to stress the importance of saving enough money for retirement.

The term “retirement readiness” usually refers to the ability to replace 75% to 85% of preretirement income. This figure doesn’t provide a “dream” retirement, but it’s enough to pay for food, shelter and clothing. To accommodate these basic needs, however, most employees need to start saving 10% to 15% of their income starting at age 21.

Yet many financial planners are telling retirement plan participants to save enough only to qualify for the company match. Big problem! Even personal finance guru Suze Orman has suggested other savings vehicles are better options than a company retirement plan if it doesn’t offer a match. Yikes!

According to the 2011 annual Plan Sponsor Council of America Survey, 95% of plans offered a match; the average in 2011 was 2.5% of pay. Typically, employers provided a match up to 6% of an employee's salary, according to 401k Help Center. Additionally, about 23% of employers offered a matching contribution of 50 cents per dollar—again up to a specified percentage of pay, usually 6%. These statistics clearly show that we have wronged the participant. Even if all employees saved 6% of their pay and received a 3% match, they still could not save enough to meet their basic minimum needs in retirement. Our industry's laser-focus on company matching contributions has fallen well short of helping participants achieve retirement readiness.  

What's more, we put an unfair burden on plan sponsors by insisting that a match was vital to the plan's success.  Employers have limited budgets for retirement plans, and they need to use them effectively. In recent years, we have discovered that plan features such as automatic enrollment and automatic contribution escalation are far more effective than company matching contributions to encourage participation and improve employee savings rates. And employers have made strides to embrace this trend. An Aon Hewitt survey of 210 mid- to large-size employers found 57% offered an automatic enrollment feature in their defined contribution plans in 2010. In 2011, Fidelity reported 51% of its 401(k) participants are now in plans that auto-enroll new hires, up from just 16% five years prior. And the numbers continue to improve. In fact, auto-enrollment and auto-escalation are the most impactful tools we have used to entice participants to adopt better savings habits.

Current matching formulas aren't the answer. If we wanted to do our participants justice, we would structure the match by stretching the benefit to a higher percentage of pay. For example, instead of 50 cents on 3%, make it 30 cents on 10%. This would help alleviate one of the problems we have created. According to Fidelity, the typical match could boost 401(k) plan participation by nine percentage points. This shows it has some effect, but not even close to what we need to solve our nation’s retirement crisis. We can and must do better.

Jason K. Chepenik, CFP®, AIF®, CkP  

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.