“Our findings can inform plan sponsors in designing their employer match and other plan features to improve equity and efficiency while containing costs,” said Fiona Greig, global head of Investor Research and Policy at Vanguard, who authored this paper along with Vanguard’s Anna Madamba, Yale University’s Guillermo Carranza and Cormac O’Dea, and Massachusetts Institute of Technology’s Taha Choukhmane and Lawrence D.W. Schmidt.

The paper assesses how equitable employer contributions are by evaluating how employers distribute their match. The top 20% of earners (Income quintile 5) receive 44% of employer contributions while the bottom 20% (Income quintile 1) receive just 6% (left-hand figure).

The authors document that those at the top of the pay distribution receive a larger share of employer contributions than their share of income. The top 20% of earners (Income quintile 5) receive an 11% larger share of employer contributions than income, while those in the bottom pay quintile (Income quintile 1) receive a 29% smaller share of matching dollars than income (right-hand figure).

“In two-thirds of plans, employer contributions are exacerbating pay inequity,” said Choukhmane, an assistant professor of economics at the Massachusetts Institute of Technology. “A key reason for this is that higher-income workers are more likely to participate in the retirement plan and save enough to maximize their employer match.” 

The research finds that, while employer contributions are an important component of total savings, employee savings rates vary surprisingly little across plans with different matches. The study found that just 13% of employees save at exactly the match cap.  

“Many people save in excess of the match cap, while others choose not to save at all in spite of incentives from typical match formulas,” O’Dea, an assistant professor of economics at Yale University, said. “This points to potential gains from more innovative match formulas that may encourage saving among those less likely to do so.”

Percent of employees and employer contributions, by employee contribution relative to the match

The costs of matching contributions are not insignificant for employers. The research revealed that one in four plans spend more than 6% of compensation on employer contributions. Dollar cap formulas cost the least because they limit the match for those with the highest earnings.

“In addition to directly impacting costs, the match formula affects the cost of other plan features, such as automatic enrollment, that do a lot to promote savings,” Greig said. “Employers may face a real tension between wanting to help workers save for retirement and containing company costs.”

No single formula is a clear winner in promoting savings, but dollar caps are more equitable and contain costs. In these plans, the top 20% of earners received a 6% smaller share of employer contributions than earnings.

“Many common formulas, including safe harbor designs, which allow employers to bypass nondiscrimination testing, exacerbated pay inequity,” Schmidt, an assistant professor of finance at MIT, said. “Policymakers could do more to promote equity by adopting additional safe harbor standards that nudge plans toward more equitable designs.”

Top earners’ excess share of employer contributions

The findings point to a number of considerations in plan design for sponsors.

For example, Greig pointed out, “Dollar caps could be used to free up employer resources to pay for plan features that could promote savings for low-income workers, such as autoenrollment, a higher-default savings rate, and immediate eligibility and vesting.”

But Greig also cautioned, “Employers have different objectives when offering a match.”

“We believe that thoughtful plan design can improve outcomes,” Greig said. “Our findings on equity, efficiency, and costs can help sponsors more effectively use their employer contribution budgets to meet their goals.”

• The next frontier of retirement plan design: 4 big ideas (commentary, issued March 2024)
• Distribution-friendly plan features increase asset retention (article, issued September 2023)
• Generational changes in 401(k) behaviors (11-page PDF, issued April 2023)