Research summary
Considering a more equitable, efficient 401(k) match
June 05, 2024
To help plan sponsors assess the trade-offs of 401(k) matches, Vanguard conducted an analysis of more than 1,300 recordkept employer-sponsored retirement plans between 2013 and 2022. The results are detailed in Are Employers Optimizing Their 401(k) Match? and include the following findings:
- Employer contributions often increase pay inequity.
- Match formulas alone do little to encourage savings. Other plan features play a role.
- Employer contribution budgets vary widely.
“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.
Are employer contributions equitably distributed?
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.”
Employer contributions are highly concentrated in the hands of top earners
Share of employer contributions, by within-firm employee income quintile
Top earners received an 11% larger share of employer contributions than benefit income
Excess share of employer contributions accruing to top 20% of earners, by income quintile
Notes: The chart shows the share of employer contributions accruing to workers, by within-plan income quintile. “Income” refers to a worker’s benefit-eligible income that can qualify for employee or employer contributions (for example, subject to the benefit compensation limit, which was $330,000 in 2022). Results are participant-weighted among 8,479 plan-years between 2013 and 2022.
Source: Vanguard.
Notes: The chart shows the excess share of employer contributions accruing to workers, by within-plan income quintile. The excess share is calculated by dividing the share of employer contributions by the share of income minus one. Results are participant-weighted among 8,497 plan-years between 2013 and 2022. “Income” refers to a worker’s benefit-eligible income that can qualify for employee or employer contributions subject to the benefit compensation limit (for example, $330,000 in 2022).
Source: Vanguard.
Do employer contributions encourage savings?
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.”
Most employer dollars are allocated to employees who are contributing above the match
Percent of employees and employer contributions, by employee contribution relative to the match
Notes: We classify employees into four groups depending on their contribution rate and the match cap of their 401(k) plan. The chart compares the shares of employees in these four groups with the total amount of employer contribution dollars allocated into the four groups. Results are participant-weighted among 8,497 plan-years between 2013 and 2022.
Source: Vanguard.
How costly are match formulas?
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.”
Do certain match formulas perform better than others?
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.”
Dollar cap plans more equitably allocate employer dollars than other common match formulas
Top earners’ excess share of employer contributions
-match/dollar_cap_plans.svg)
Notes: The chart shows the distribution of plans by excess share of employer contributions accruing to the top 20% of earners. The excess share is calculated by dividing the share of employer contributions by the share of income minus one. Positive numbers reflect regressivity. Negative numbers reflect progressivity. “Income” refers to a worker’s benefit-eligible income that can qualify for employee or employer contributions, subject to the benefit compensation limit (for example, $330,000 in 2022). Results are participant-weighted and based on 5,480 plan-years among the 10 most common formulas between 2013 and 2022.
Source: Vanguard.
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.”
Related links:
- 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)
Notes: All investing is subject to risk including the loss of the money you invest. Diversification does not ensure a profit or protect against a loss.
Contributors
