Updated: September 1, 2015
Lots of people are leaving money on the table, turning down money their employers want to give them. They are giving up an opportunity to live better. Are you one of them?
A recent edition of the TIAA-CREF Institute’s Research Dialogue (you may have seen it at your local newsstand) has a thought-provoking assessment of how individuals respond to employers’ 401(k) matching contributions.1 The article’s authors are concerned with government policy implications– do people save more if their employers offer matching contributions, should Congress encourage employers to match more, etc.? We at Sensible Financial™ are much more interested in what the work suggests about how our clients can improve their lives through increased spending power. We suspect you are, too.
- The article’s key takeaway? An employer match is lifetime spending power, not just retirement spending power. If you can get it, you are earning more, and you can spend more, both now and in retirement.
The study looks at a national sample of employees whose employers offer a wide variety of 401(k) type plans, and a broad range of matching opportunities. You may think that 401(k) plans are pretty standard. Not so!
Just over half of employers match employee contributions, and most of those that do have fixed (e.g., 50¢ on the dollar up to 3% of compensation) rather than variable (e.g., 50¢ on the dollar up to 1% of compensation, 25¢ on the next 1%) matches.
Companies that do match contribute widely varying percentages of compensation, a few are under 3%, while a very significant percentage matched 6% or even more.
The data are about 15 years old (the sample was drawn in 1992). The employees range in age from 51-61 – certainly older than the national average, but also closer to retirement, and arguably much more interested in saving than their younger colleagues. My experience as an economic researcher (admittedly dated now) suggests that the authors used very rich data – they know a lot about the people they studied (including Social Security earnings history) and the 401(k) plans they participate in (e.g., plan descriptions). They’ve used the data carefully (using “non-linear budget set estimation”), and they’ve learned a lot.
The most striking finding is that some people whose employers offer matching contributions don’t bother to participate in the plans. People who don’t participate at all leave an average employer match of 3.7% of their pay on the table – almost 4%! For $50,000 earners, that’s $1,850; for $100,000 earners, it’s $3,700. That’s not chicken feed – it’s a couple of monthly rent checks, or mortgage payments, or several car payments. For those that earn even more, well, we’ll leave the math to you.
Even those who do take advantage of the match often don’t take full advantage. They leave an average of 1% of the employer’s offered match unused, in effect saying to the employer, “no thanks, keep your $500 or $1,000, (or more), I don’t want or need it.”
The researchers do find that larger matches from employers encourage more saving, but not dollar for dollar. That is, larger employer matches encourage more saving than smaller matches do, but also leave larger unused matches.
So, the bottom line – there are a lot of employer dollars out there ripe for the taking, and people are leaving them. It is often said that money doesn’t grow on trees, but here’s a case where it does, and people are refusing to pick it. Why?
The authors don’t address that question, but we’ll take a swing at it. We can think of three reasons – none of them good – and we’ll tell you why:
- Reason # 1: People don’t know how much of a match their employers are offering.
This is not a good reason because employers must, by law, inform their employees about any 401(k) plan they offer, and about any contribution matching that is part of the plan. That means that people who don’t know about the match “aren’t reading the memo.” Do you think they might read the memo if it said at the very top – “read this memo and get a raise?” In fairness, the employer information documents are frequently not simple, and the information about the match may be “well defended.” People are busy. Still, are they really too busy to spend an hour to get a raise?
- Reason # 2: People do know about the match, but don’t take the time to fill out the forms.
This is even a worse reason: how much time is it worth to you to get a 1-3% raise? (Hint: 2 days is 1% of the working year, 6 days is 3%). In fact, the benefit of reading the forms once is even greater, because most people don’t change their 401(k) choices once they’ve made them. Signing up for the match now is likely to mean that you’ll keep getting it, year after year.
- Reason # 3: People know about the match, but “can’t afford” to save more now.
This is perhaps the most understandable reason – people may think they have to give up spending power now for spending power after retirement, and may legitimately not want to do that. However, this isn’t a good reason either – there are ways to have your cake and eat it, too. Specifically, you can borrow the money to attract the employer match. We don’t recommend taking out a consumer loan, or credit card borrowing. However, you can take out a home equity loan, or pay off your mortgage a bit more slowly. You have to have good spending discipline (or that extra borrowing can balloon), but in return you get more retirement savings without giving up any current spending power.2 In fact, you can get both more retirement savings and more current spending power.
Here’s how it works. Suppose that your employer has promised to match 100% of your 401(k) contribution up to $1500 per year. The table assumes interest rates of 8% on your mortgage, expected returns of 8% on 401(k) assets, and the 25% income tax bracket. The results are similar for higher tax brackets. Contributing $1,500 to your 401(k) reduces spending power by $1,125 this year (you have to pay $375 in taxes on $1,500 to get $1,125 in spending power). Suppose that you borrow that $1,125, and then another $1,125, in effect spending the whole employer match this year. Suppose further that you borrow to pay the interest on your $2,250 loan. After 30 years, your loan will have grown to $13,748, but your 401(k) will have grown to $22,641 after tax – you’ll have another $8,893 to spend after retirement. That’s having your cake and eating it, too – spending the equivalent of your employer contribution this year, and then having more to spend after retirement.
The second column shows the benefit of repeating that strategy every year for 30 years. Every year you get $1,125 of extra spending power – repeating for 30 years produces a total of $33,750 extra. Every year you borrow $2,250, and accumulate the interest due, too. Every year you save $1,500 in your 401(k) account, and your employer adds another $1,500. After 30 years, you’ve accumulated $370,038 in your 401(k), pay 25% in income tax, and end up with $277,528. After paying off your $190,804 loan, you have $86,724 more in spending power. Now, that’s a raise! And all due to accepting your employer’s offer of a 401(k) matching contribution – hard to turn down, isn’t it?
Here’s what you can do to be sure to scoop all that money off the table:
- At least skim the annual document about your employer’s retirement plan– find out what 401(k) matching your employer offers. (You should also find out what your investment options are – another topic for a future issue of Sensible Thinking).
- Figure out how much retirement saving you need, including the employer match. This will depend on a few key factors, most importantly the number of years you expect to work until you retire, the number of years of retirement you intend to finance, and your earnings. With these pieces of information, you can determine your new sustainable living standard3 (it will be higher than if no match were available) and your annual savings.
- Decide to contribute enough to obtain the full amount of employer matching dollars – at least to the 50% level. If this doesn’t take you beyond your new target retirement savings level, fine (be sure to count the match as retirement savings!). You’ll be able to save less in your other retirement accounts (and spend more every year) as a result of your employer’s generosity. If you are already saving enough for retirement, just saving more will increase your living standard after retirement, but will also reduce your living standard now. Look hard for a low cost way of financing your additional 401(k) contribution. If the cost of financing is too high (higher than you expect to earn on your retirement savings), you’ll erode, or even eliminate, the benefit of the employer match.
If in doubt, talk with a trusted financial advisor about these options and see if increasing your match is feasible. A professional financial advisor will be able to decipher difficult to read employer plan documents and help to ensure that you’re reaping the most from your employee benefits. If you have questions about your employee 401(k) benefit or employer contribution match, give us a call at 617-444-8677, we’d be happy to discuss your options and help you select a plan/contribution option that’s right for you.