Missing the Match
401(k) Plan Match = Major Incentive
One key plan design aspect of 401(k) plans and a significant draw for employees and employers alike is the ability of the plan sponsor (employer) to include matching contributions in the plan. Not only does the match incentivize employees to participate in the plan, it also increases overall contributions in participant accounts. Furthermore, including a match may allow the Highly Compensated Employees to save more in the 401(k) plan.
How can you “miss the match” in a 401(k) plan?
1. Deferral Percentages That Don’t Meet the Match
To receive an employer matching contribution in a 401(k) plan, a participant (employee) must first agree to make a salary deferral (have money withheld from their paycheck and deposited into the 401(k) plan). The employer portion is called a match because the employer is “matching” the money the participant puts into the plan. The employee must have “skin in the game” as the saying goes. They can normally choose to have a certain dollar amount or a certain percentage of their gross pay withheld.
How does an employee miss the match? First, by not signing up to make a deferral out of their salary. Secondly, and most importantly, by not understanding the matching contribution that the employer is making on their behalf and how it is calculated.
For example, let’s assume an employer matches the first four percent of gross pay that a participant defers into the plan dollar-for-dollar. That means, if a participant defers four percent of their paycheck into their 401(k) account, the employer will match that four percent, for a total of eight percent in total contributions to their account.
Gross Pay: $1000
Employee Deferral Contribution: $40
Employer Match: $40
Total contributions to the plan: $80
However, if the participant only defers three percent of their pay, the employer match will only equal three percent of their gross pay or $30 in the example above. So, the participant misses one percent of the matching funds the employer provides (in this example, over 52 pay periods that would be $520 for the year). In other words, he passes up free money from the employer every pay period. In this example, it’s the same as giving up a guaranteed 100% return on your investment, and you can’t get that type of guaranteed return on any other investment.
2. Maxing Out Deferrals Early
Another way a plan participant can miss the match, which often comes as a surprise to everyone, is by deferring too much out of each pay period early in the year in order to maximize their deferrals early on. This is another reason why it is so important for everyone to understand how the employer’s match is calculated. Oftentimes this scenario even surprises the employer.
Let me explain.
There are limits, set annually by the IRS, regarding how much a participant can defer (or contribute out of their pay) into a 401(k) plan. The maximum amount a participant can defer into a 401(k) plan in 2018 is $18,500.
The schedule for calculating and depositing 401(k) matching contributions varies from plan to plan and is normally stated in the plan document and summary plan description. Many plan sponsors opt to calculate and deposit their employer match each pay period. It’s better for the participants because those funds are deposited earlier and can be invested sooner. A plan may also calculate and contribute the match at year end. Depending on when the plan sponsor chooses to calculate and contribute matching dollars, an employee contributing the maximum amount of deferrals ($18,500 for 2018) may miss some of their potential match if they try to contribute all of it early in the year rather than equally out of each paycheck during the year.
Mr. Scott, a plan participant in the Enterprise 401(k) Plan, is paid semi-monthly and receives 24 paychecks each year. Each paycheck his gross pay is $3,125. He decides that he would like to contribute $18,500 out of his pay into the Enterprise 401(k) Plan this year. He also decides that he would like to make his contributions to the plan and invest as early in the year as possible. He decides that he can afford to contribute $1,028 per pay period into the 401(k) plan. His employer will match his deferrals dollar for dollar up to 5% of his gross pay, calculated each pay period. His match each pay period will be $156.25 ($3125 * 5%). He will reach his deferral limit of $18,500 after 18 paychecks rather than using the full 24 pay periods in the year. This means that his total employer match will be $2,812.50 ($156.25 for 18 pay periods). After his last paycheck in September, his deferrals will be $0. Therefore, his employer match will be $0 as well.
Ms. Uhura read her summary plan description. Therefore, she knows that the employer match that she will receive in the Enterprise 401(k) Plan will be calculated and deposited each pay period. If she does not have a deferral taken out of one or more of her paychecks, she will not receive a match for that pay period either. She also makes $3,125 each pay period, and she wants to be sure to reach the maximum deferral of $18,500. She divides $18,500 by 24 so that she will have an equal amount of deferrals taken from each paycheck and by the last paycheck, she will reach her goal of maximizing her deferral at $18,500. She will defer $770.83 from each paycheck and she will receive an employer match of $156.25 each pay period. However, because she spread her deferral out equally over all of her paychecks and made sure that she had a deferral of no less than 5% from each of her paychecks she will receive a total employer match of $3,750 ($156.25 * 24). Because Ms. Uhura read her summary plan description, made sure she understood how her employer calculated the matching contribution, and she made sure that she was able to defer from each paycheck throughout the year, her total match for the year exceeded Mr. Scott’s total match for the year by $937.50, even though their gross pay and their total deferrals for the year were the same.
The key to a successful retirement savings strategy is committing first to consistent savings by deferring a percentage of your pay into a retirement plan. Secondly, it is important to take the time to understand your employer’s plan and how the match is calculated. Finally, you should take advantage of any match your employer may provide and make sure that, at a minimum, you contribute enough to receive the maximum matching contribution available. Don’t leave free money on the table!