Matching contributions

I started reading a paper, found here, because a blurb made it sound interesting and touched on some pet peeves of mine.  The “interesting” part, not so much; it is filled with text such as this:

Retirement plans emerge in equilibrium, however, if instead workers suffer from some degree of present bias or myopia, which would generally lead them to save less for retirement than they would prefer ex ante. Sophisticated myopic workers understand their self-control problem. The problem for a sophisticated worker is to choose a contract with a retirement plan that induces her future self to save optimally. This can be achieved through non-elective employer contributions, locking in some level of retirement savings, or matching contributions, counterbalancing her present bias. Sophisticated myopic workers in equilibrium receive a retirement plan that provides a first-best commitment device.

Whoa.  Only so many hours in a day there, fellas, 79 pages of that is a little much.

Anyway, (I think) one of the main points is that matching contributions (for the totally uninitiated and un-intuitive readers, matching contributions are employER contributions that match a portion of employEE contributions, usually 25% to 50%), which logic says are an inducement to help workers save more, don’t necessarily accomplish that goal.  I’ve been saying that for years, in fact, one of my favorite sayings about retirement plans is “matches are for starting fires.”  (That’s not original on my part; I first heard it from Larry Starr, one of my mentors in this business.)  Although a few of our plans do have matching contributions, most of them do not.  The reasons are an interesting mix of liberal and conservative ideology, which mirrors my own, somewhat confused, “see all sides” way of thinking; boiling down to these points:

  • Most of our plans are rather small, and are in place largely to serve the interests of the owners as tax shelters. As such, benefits tend to be skewed towards the owners, and they are typically “top heavy,” meaning the owners have more than 60% of the account balances.  Top heavy plans must generally make a 3% employer contribution for all non-owners, and matching contributions don’t count.  So we design the plans to make those contributions from the get-go, and layer on additional contributions as appropriate to serve the owners’ purposes.  Matching contributions are subject to certain tests and simply don’t (usually) do much for us in this regard.
  • For sponsors who want their retirement plans to provide a meaningful retirement benefit to their employees (what a concept!), matching contributions are definitely not the best vehicle for a significant part of their workforce – the truly poor, who simply cannot afford to make any employee contributions (or the stupid, who won’t). I lost a client once; they had an old-fashioned plan where everyone shared in “nonelective” employer contributions.  The CEO kept pressing for a 401(k) plan with matching contributions instead of nonelective; I said “I agree with adding the 401(k), but if you change the nonelective to match, a substantial number of participants won’t get anything.”  This was a non-profit organization by the way, which employed a lot of low-paid workers.  Unfortunately for most everyone involved except the CEO (and the broker who increased commission costs), they made the change anyway, and dropped us in the process.  I don’t regret opening my mouth.

Basically, matching contributions reward those who can contribute, often at the expense of those who cannot, if the company is operating under a budget, which most are.  That’s a really warped result when you think about it.  But our US retirement plan system is kind of a warped mess anyway*; we’re just picking around the edges trying to make things work as best we can.  I am proud to say that I have a fair number of clients who make substantial contributions – 10% to 25% of pay – fairly consistently.  Now that‘s a “retirement” plan.

If I manage to slog through the rest of the paper, I may have further comments – I think they are on the right track.

*I came into the business at the tail end of “the good old days” when defined benefit plans were the norm; these promised a benefit that was totally funded by the employer.  They are now largely out of favor, largely because of costs – my guess is that the typical cost per employee averaged 5% to 10% of pay; employees didn’t know this because they didn’t see it on a piece of paper.  I have a report floating around on my desk that says the median matching contribution is 3%.  3% is less than 5%, so employers have largely migrated from defined benefit to defined contribution plan (specifically 401(k) with a match) and employees haven’t protested much because it didn’t affect their paychecks.  Unfortunate but true.