News, Analysis, and Research for the Retirement Planning Industry

Rethinking Our Approach To 401(k) Matching Contributions

In Uncategorized on 3 March 2011 at 12:59 am

The employer match or “free money” is major motivator used to encourage employee participation in 401(k) plans. The most common employer matching structure is 50% of each dollar up to the first 6% of employee contributions. The conventional wisdom heard by most participants is to contribute “at least up to your employer’s match.” In practice, it appears the “at least” part is ignored; the average deferral rate for non-highly compensated employees is 5.5%, while the average for HCEs is 6.6%.*

Unfortunately, 6% (or even 9% with the typical match) is not nearly enough to fund a 30+ year retirement, and very few participants are saving enough outside of their 401(k) plans to make up the difference. Can applying behavioral economic theory to matching contribution structure increase deferral rates?

Though there has been much discussion on using behavioral economics to influence investment selection and increase 401(k) participation and deferral rates, there is one idea to increase deferral rates that I have yet to hear discussed; backloading the match so that the more participants contribute, the higher the matching rate.

To encourage greater employee deferral rates, many companies have increased their matching rates (say from 50% of the first 3% to 100% of the first 3%). A January 2005 study by Watson Wyatt suggests such an increase in the match ratio would actually cause worker contribution rates to decrease. There is some evidence to support that conclusion.

Consider 1st United Services Credit Union, featured in September 2010 article by Emily Brandon of U.S. News & World Report. The credit union provides a very generous $1.40 for each dollar contributed by an employee, up to 5% of pay (the $.40 is not fully vested for 5 years). The credit union has an enviable 91% participation rate, but their average deferral rate: an industry average 6%.

Suppose 1st United left their maximum match (7%) unchanged and restructured their matching schedule as follows:

Employee Contribution Rate Company Match
<2% 0%
2% – 4% 25%
4% – 8% 50%
8% – 10% (or max) 70%

Employees would be required to contribute an extra 4% of their salary to get the full 7% company match. The actual inflection points for the company match used in a plan like this should be based on where deferral rates drop off in order to encourage “stretch” savings behavior, with the goal of maximizing total (employer and employee) contributions.

Challenges to implementing a backloaded plan:

  • Nearly one-quarter of plans offer a safe harbor match. A backloaded plan would not satisfy the safe harbor criteria, so employers switching from a safe harbor match would now be subject to ADP/ACP testing.
  • The goal is to increase total contributions for all participants. Care needs to be taken that inflection points are not too aggressive so as they discourage non-HCEs from participating (or reducing their deferral rates). This is important not just for the fairness and best interests of lower paid employees, but also to ensure non-discrimination testing is passed. The more economically diverse the workforce, the greater the challenge, particularly in the initial year the backloaded match is implemented.

Several companies take the opposite approach and frontload the match. Home Depot matches $1.50 for every participant dollar up to 1% of pay, and then 50 cents per dollar on the next 2% – 5%.** McDonald’s, featured in the same article as 1st United, is even more generous with $3 for the every participant dollar up to 1% of pay, and then a dollar for dollar match on the next 4%.

Many companies that take a frontloading approach to the 401(k) match have a large percentage of their workforce at lower income levels. The rationale is that these workers can afford to save only a small percentage of pay and the employer wants to “push” more of the match down to them.

Pushing more of the match down to lower income workers is certainly an admirable goal, and providing these outsized rewards on the first dollar undoubtedly increases participation rates. McDonald’s automatically enrolls restaurant managers at 1% unless they opt out or change their level. 98% of these managers participate in the plan. But does the incentive also reinforce saving at the minimum level?

With an average salary of about $36,000 (according to, it is not likely the majority of McDonald’s restaurant managers can afford to save 10% of their salaries, but if 98% can afford to save at least 1%, they could probably save 2%. Suppose 30% of McDonald’s employees only contribute 1%. McDonald’s might change their match so that it contributes 0% for the first 1% of salary and 4% for the second 1%. Those contributing at least 2% before the matching change are not affected, but there is a strong incentive for the 30% of participants only contributing 1% to contribute at least 2%.


Though the structure would necessarily vary based on the profile of an employer’s workforce, it appears as though there opportunities to use some kind of matching program that is based on rewarding incremental employee savings.



* “52nd Annual Survey of Profit Sharing and 401k Plans,” Published By:  Profit Sharing/401k Council of America

**Brandon, Emily. “The 401(k) Match’s Big Role in Retirement Security.” U.S. News & World Report, 24 September 2010. Web. 3 March 2011.

  1. […] are lots of ideas on increasing employee contribution rates, and I have blogged about a couple. These generally require some kind of new strategy on the part of the plan sponsor. Let’s […]

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