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401(k) Matches Don’t Work


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November 22, 2005

401(k) Matches Don’t Work

Michael Mandel

Here's a post from my colleague, Peter Coy:

Until now, evidence on the efficacy of 401(k) matches has been mixed. Some studies have indicated that workers are much more likely to contribute to 401(k) plans if the company offers to match their contributions. Other studies have found only a small effect. But all the studies have been too small to be conclusive.

Finally, some serious evidence is in, and it’s a surprise. A new study based on 500 retirement plans covering 740,000 workers concludes that the matches are extremely ineffective in getting more people to contribute. In the typical 401(k) plan, only 10% of non-highly-compensated workers are induced to save more by match incentives, concludes the study by Olivia Mitchell of the University of Pennsylvania’s Wharton School, Stephen Utkus of the Vanguard Center for Retirement Research, and Tongxuan (Stella) Yang of Penn.

It might strike most economists as unfathomable, but it appears that most American workers just aren’t motivated by the free money of a company match. Write the authors: “We are left with a strikingly strong level of savings aversion, apparently quite resistant to substantial economic incentives.”

If matches don’t work, what does? The authors point to work by others (like her Wharton colleague Brigitte Madrian) on the success of automatic enrollment, where workers have to opt out of 401(k) plans instead of having to opt in. Another choice: Automatic employer contributions to workers’ 401(k) plans, regardless of whether the employees contribute or not.

Of course, all this assumes that companies’ main goal is to ensure that all employees accumulate retirement savings. The fact is, some companies may regard generous 401(k) matches as primarily just another form of compensation for the middle and upper managers who are most likely to take advantage of the matches. Or the companies may be aiming to recruit young employees, who generally aren’t much interested in saving for retirement and wouldn’t be impressed by automatic employer contributions in 401(k)s. For these types of employers, a company match may work just fine.

One thing’s for sure, though. If you’re running a retirement plan that’s at risk of running afoul of the non-discrimination rules because it’s top heavy with high-income participants, don’t kid yourself that upping the employer match will get lower-income workers to join in droves. It just won’t happen.

04:32 PM

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People just don't have long-term vision. If the income tax rate (fed + state) is 35% and the company matches 20%, that means they are choosing to have $6.50 available now, rather than $12 in their 401(k).

Then again, half the population doesn't know that the Earth goes around the sun in one year, and 60% can't name more than 5 former US Presidents.

The answer to the 401(k) problem, and just about every other, is education. Personal finance should be a mandatory high-school or college subject. It probably has a higher ROI than any one single course a young person could take.

Posted by: Kartik at November 22, 2005 06:44 PM

Interesting... and sad. My current employer offers 6% matching funds and auto-enrolls new employees at 3% participation rate.

Anecdotally, I note that it the Gen X and Y employees who seem to have a need to show off their latest digital gadgets, high-end vehicles, and upgrade in homes. Not a hint of frugality or a sense of net worth there... so I'd expect they are non-participants, even though our wages are similar, and they should be able to afford to save.

On the other hand, a number of us Lost Generation (NOT BOOMERS, Dammit!) age employees have compared notes, and we always maximize our contributions. In fact it's necessary to avoid hitting the max contribution limit early, as you will then be earning income the company *won't* be matching afterwards, and losing matching funds.

What also strikes me as funny is my inlaws... Children of the Great Depression, who actually know what it's like to be hungry and to go without. They spend more time and effort planning their vacations than they did their retirement. And of course their vacations are more successful than their retirement. He's 71 and he can't afford to stop working, even though by Friday morning he's too exhausted to get out of bed. Bad Karma, eh?

Posted by: Idaho_Spud at November 22, 2005 10:06 PM

I wonder if this has to do with the increasing number of employers reducing or dropping matches. A large number also use vesting periods so long that actual matches are much smaller than proposed. Five years used to be a short period but with churn in the economy, this is now long term employment and you are lucky if both you and your employer are still around that long.

I agree financial education is sorely lacking and many probably just don't want to learn about investing.

Posted by: Lord at November 23, 2005 01:36 PM


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