An unwelcome twist to employer 401(k) matches

Dollar sign in a nest

IBM recently announced it will offer a 401(k) match once a year in December instead of with each biweekly paycheck.

IBM isn’t the first company to implement such a policy — 7% of companies that contribute to employee retirement accounts made lump-sum payments in 2011, and 8% did so in 2010 and 2009, according to a survey of 430 plan sponsors by the professional services firm Deloitte.

But Forbes says Big Blue has the second most employees of any U.S. firm, so what IBM does is worth paying attention to.

I wondered how likely other companies might be to follow IBM’s lead and how the change would affect employees’ retirement savings.

The short answer to my second question: IBM's plan is bad for employees.

When Companies Match

Frequency Percentage of firms
Each pay period 83%
Annually 9%
Monthly or quarterly 8%

First, you'll lose money in the short term because you receive the money later. That means missing out on the appreciation your investments could have earned throughout the year.

"Assuming a 7% return on investments, the matching account would be about 3.3% less that it would have been if the matching contribution was made on a biweekly basis," retirement planning expert Rich Rausser says.

Rausser, senior vice president of client services at Pentegra Retirement Services in White Plains, N.Y, explains how the math works using a $100,000 salary for simplicity. In these scenarios, the employer matches a portion of the employee's contributions up to a certain percentage of overall salary.

The first amount is what the employer contributions would be worth at the end of a year with an annual match; the second amount is what the balance would be with a biweekly match.

What an Annual Match Costs Employees

Match percentage Paid annually Paid biweekly
3% $3,000 $3,102.81
6% match $6,000 $6,205.62
8% match $8,000 $8,274.16

Second, you'll lose money in the long term because the small losses associated with receiving the money later each year compound over time.

Rausser says that for an employee earning $50,000 a year with 6% deferred into their 401(k) plan and a 6% matching contribution, the loss will amount to nearly $30,000 over 40 years, assuming a 7% annual investment return and no salary increase. The resulting balance is 91% of what it would have been if the matching contribution were made each pay period.

The third drawback?

"By only receiving a lump-sum payment at the end of the year, employees will not be able to utilize the strategy of dollar-cost averaging," Ryan Himmel, the CEO of BIDaWIZ, an online marketplace for professional tax and financial advice, writes on the company's blog. "This strategy helps employees reduce their risk by purchasing investments at various price points throughout the year."

"Participants buy more shares of an investment fund when markets are low, and they buy fewer shares when markets are high," Rausser explains. "Regular and consistent contributions to the plan — both employee and employer — are one of the best ways for plan participants to take advantage of dollar-cost averaging."

If you receive an annual match, you might wonder how you can counteract its negative effects.

Some employees might be tempted to move into riskier investments to try to make up for the lost returns, but Rausser advises against this.

Instead, he recommends that employees increase their 401(k) contributions to make up for the long-term disadvantage of receiving the employer match at year's end.

As to whether other businesses will follow suit, opinions are mixed.

Rausser doesn't see a trend in the making.

"A year-end match tends to send a negative message to the plan participants," Rausser says. "A match that is made every pay period rewards employees and encourages them to contribute to the plan on a consistent and regular basis."

Himmel, also a CPA and registered security analyst, says he thinks the annual match will catch on because it saves companies money.

It also allows employers to focus their matching contributions on loyal employees who have remained with the company all year, says Karen Smith, president of Nova 401(k) Associates, a third-party administrator for retirement plans.

"If an employer has a fixed budget, it makes sense that the employer would target that budget towards ongoing employees and not worry as much about employees who quit," she says.

But a switch to annual matching contributions could have unintended consequences for employers and employees alike.

Rausser says plan participants may reduce their savings rates if they view the year-end match as less of a motivator and less of a guarantee that they will receive the match.

"In addition, this could have an impact on the ability to attract new, highly qualified employees since this is a less generous plan design," he says.

It could also cause problems for employee retention and a prompt a year-end exodus of employees right after the matching contribution is deposited, Rausser adds.

One thing workers shouldn’t worry about is getting laid off just before the contribution date because their employers want to save money.

Smith says that Employee Retirement Income Security Act rules prevent employers from firing an employee right before they become eligible for a benefit, just to save the employer money.

"So, yes, some employees who voluntarily or involuntarily leave right before the eligibility date for the contribution will miss out, but I don’t think that you will see large employers gaming the system by firing people right before the eligibility date," Smith says.

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