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For over 30 years now, 401ks have been the retirement savings option of choice for most employers and employees alike, which is an impressive feat for an investment vehicle that was initially created by accident and which many experts believe is not particularly well-suited to play the role of pension replacement in which it has been cast.
Despite those and some other inherent shortcomings, however, 401ks dominate the retirement savings landscape and show little sign of slowing down.
Perhaps in part as a result of the impromptu nature of their genesis followed by meteoric rise to becoming a familiar term around most American kitchen tables, however, the way they are actually constructed -from percentage match to auto-enrollment and auto-escalation, vesting schedules and fees - varies wildly from one company to the next. These features have a dramatic effect on what it costs a company to fund and offer a 401k to the value an employee actually derives (or doesn't).
Over a five year period, for an $80K salary, the difference between a 1% match and a 6% match is the difference between an employer contribution of $4,500 for 1% and $27,000 for 6%, assuming modest investment returns. The difference is $20K+ for an $80K year employee. That is just five years, imagine if that were compounded over 20-30 years.
Given their prominent position that 401ks hold in the context of modern workforce management, a closer look at some of these issues can not only help ensure that your organization’s offerings remain viable relative to the other employers with which you are competing for talent, but can also help you restructure your 401k offering in a way to maximize employee appreciation and the value generated through these benefits.
The following information is primarily drawn from data collected through Mployer Advisor’s annual Insights survey combined with government and other publicly available data sources.
The Revenue Act of 1978 included a provision that was intended to enable employees to defer some of their compensation from bonuses or stock options tax free, but a benefits manager at the Johnson Companies recognized the new law - specifically, section 401(k) of the revenue bill - made it possible for the company to offer its employees savings accounts with a major tax advantage attached.
By 1981, the IRS had issued rules that made it possible for employees to make contributions to those 401k accounts via deductions from their salaries, and just 2 years later nearly half of all of the largest US firms offered (or were considering offering) 401ks.
Even though participation in retirement account savings surpassed defined benefit plans and pensions by about 1991 (around 10 years after they were introduced in earnest) it took another 20 years for total wealth and savings contained in those defined contribution retirement accounts to exceed the value of pension assets likely on a permanent basis.
Currently only, about 15% of private employees in the US have access to defined benefit plans like pensions, and only 11% US workers opt in to those plans, whereas about 66% of private employees in the US have access to defined contribution plans like 401ks and nearly half (48%) choose to participate, which further underscores just how dominant 401ks are currently in the retirement saving space.
As the following graphic clearly demonstrates, there is a direct correlation between the number of workers that a given company employs and the prevalence of 401k offerings among similarly situated companies of approximately the same size.
As companies grow larger in size, they become increasingly expected to provide a retirement benefit. 85%+ of companies that have 500 or more employees offer a 401ks. That number holds relatively constant, drifting a little south, until you reach smaller employers. Even among smaller employers, offering 401ks has become the norm, with more than 6 out of 10 organizations (61%) that employ between 25 and 49 employees offering 401ks, while almost half of organizations (48%) with between 2 and 24 employees offering 401ks, as well. It costs money to even offer a 401k, even without a match. It is voluntary for a company to
The trend line is clear, and it is intuitive that larger organizations with more employees will also be more incentivized to offer a wider range of incentives in addition to being better equipped to handle the additional administrative workload involved, but the more important takeaway may be just how widespread the adoption is at the lower end of the employee count spectrum.
401ks are nearly everywhere, which is a reality that shouldn’t be ignored in an era during which many employees can work from nearly everywhere, employers are competing with other employers from nearly everywhere, and benefits offerings have become a more prominent point of differentiation perhaps than ever before.
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The 401k match is the biggest factor for a 401k. This component is what costs the employers the most money and also benefits the employee. This sets the bar.
As the following graphic illustrates, the average 401k contribution match is about 3.8%, meaning about half of all companies offer matching of 3.8% or more while about half of companies offer less than 3.8%.
Further, 8 out of 10 companies offer 401k contribution matching between 2% and 6% of employee income, so that is the range in which the vast majority of companies operate, with only 10% of companies falling below that range (down to 0% for those companies offering no 401k matching) and 10% of companies falling above that range (up to about 10% contribution matching on the more generous edge of the spectrum).
Where does your employer fall on this chart? Do you communicate the value of your 401k offering?
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While offering 401ks and matching contributions are obviously necessary steps for employers to take in order for employees to benefit from these opportunities in the first place, these steps alone may not be sufficient to fully realize the talent attraction and retention advantages that can accompany 401k and matching contribution offerings. To those ends, two features that have been shown to have a material effect on employee saving are auto-enrollment and auto-escalation.
While the cost difference for an employer for using these auto features or not may be negligible in the short term, the additional savings that employees can accumulate in the long term can be substantial, which in turn can have a substantial effect on how favorably an employee views their employer and benefits offerings generally.
Auto-enrollment in employer 401(k) offerings serves as a crucial mechanism for ensuring that a larger segment of the workforce participates in retirement savings plans. Without such measures, a significant portion of employees, particularly those who might benefit the most, such as younger or lower-income workers, may not enroll due to lack of awareness, procrastination, or perceived complexity in the enrollment process. This is a concerning scenario, as it leaves vulnerable groups without the means to save adequately for retirement. While implementing auto-enrollment does indeed incur additional costs for employers due to higher participation rates, the long-term benefits to employees' financial security are substantial.
Similarly, auto-escalation provisions in 401(k) plans are designed to gradually increase employees' savings rates over time, often in tandem with annual salary increments. This feature not only boosts employees' retirement savings but, in cases where employers match contributions up to a certain percentage, also increases the amount employers contribute. Though this represents an additional financial commitment for employers, it plays a vital role in encouraging employees to save more towards retirement without actively having to adjust their savings rate annually.
As the following graphic indicates, only about 42% of US employers offer auto-enrollment, while only 25% offer auto-escalation, which represents a real opportunity for employers to differentiate from the much of the competition on this front.
Both auto-enrollment and auto-escalation embody forward-thinking components of retirement savings plans that, while optional and costly for employers, significantly enhance employee benefits. Employers who adopt these features are making a commendable investment in their workforce's financial wellbeing. It's imperative for businesses offering these benefits to communicate their value effectively, highlighting that not all employers provide such advantageous provisions. This communication not only showcases the employer's commitment to employee welfare but also helps in attracting and retaining talent who value financial security and employer support in achieving it.
By taking some of the uncertainty and user error out of the process, employers can virtually guarantee enhanced saving opportunities for their employees by automatically enrolling them as soon as applicable and by increasing contribution amounts on a set schedule in line with employee goals.
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Similar to the advantages that 401k auto-enrollment and auto-escalation can provide, features that improve the accessibility and distribution of 401k funds can serve as a point of differentiation, as well, which can also increase applicant attraction and employee satisfaction in a way beneficial to employers.
For example, when and how the matching 401k contributions vest can have a material effect on both the perceived and real value of the benefit as well as on the timeframe in which workers may choose to leave their jobs for employment elsewhere.
Currently, a plurality of employers offer immediate vesting for matching contributions, which is the most advantageous option from a worker perspective, but at just 36% there is still more than enough room on this bandwagon for employers wishing to capitalize on the opportunity to shape their benefits in a way that will be even more appealing to employees.
Somewhat less-favorable to employees is graded vesting, which vests the matching contributions little by little over an extended period of time, which about 32% of employers utilize, while about 27% of employers arrange their matching contributions to vest all at once at a specified date in the future, which is known as cliff vesting and is probably the least appealing option to employees because it requires them to wait longer to obtain legal ownership of those contributions provided by their employer.
As for 401k distribution, there is much less parity among companies in terms of the adoption rates of the various options, with distribution via annuity offered by nearly 9 out of 10 employers (89%). Nearly half (42%) offer distribution via installment payments while only about 12% offer lump sum distribution.
Given that employers can offer more than one possible method for distribution, of course, the operative questions become which option or options will best service the needs of the employees and how to best go about providing those options.
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The facts -
- Employers do not have to offer a retirement plan
- Retirement plans are expensive, especially when considering the match percent
- Plan features can have an extreme impact on the 401k, both in terms of employer cost and employee long term benefit
- If you offer a rich 401k - 1. make sure you know that and 2. communicate it because it can be a great driver for retention and attraction
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