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Firms should weigh benefits of 401(k) changes
Annual matching contributions can save money, but how will employees react?
Companies looking for cost savings could find them by switching to an annual 401(k) matching contribution versus the more common per payroll contribution, but there are a few downsides to consider.
Attorney Heidi Lyon, of Warner Norcross and Judd, said the main reason a business might want to consider making its 401(k) contributions annually is that it frees up the company’s cash flow and helps control costs.
“If you are putting money in throughout the year, you are paying that out of your pocket as you go,” she said. “If you do it once a year, you are paying it in after the plan year ends, so you get the use of that money to fund the match for the whole year.”
Additionally, if a company puts an end-of-year employment requirement in place, any employees who leave the company before the last day of the year will forfeit the company match, potentially saving the company money — particularly, larger companies or those with high turnover rates.
“It allows the company to avoid matching funds of employees who have left during the year,” Lyon said. “A lot of companies like that idea because they want the money they are putting aside to go to their employees and they want there to be an incentive for people to stay.”
Generally, employees have viewed a switch from per-payroll matching contributions to an annual one negatively. In fact, earlier this year, Fortune 500 company AOL backtracked on its decision to make the switch following employee backlash.
“One of the reasons that employees get concerned about the change is that it means the money isn’t getting into their account as soon as it used to, and a lot of times they will end up better off if the money goes in earlier in the year because it would be invested throughout the year,” Lyon said. “That is the downside to it and why employers have to be careful when they are doing it, because it has the potential to upset people.”
Terry Seely, a financial advisor at Capital Ideas in Grand Rapids, agreed that employees generally see the move as putting them at a disadvantage from an investment perspective, but he said it isn’t always the case.
“Where it draws the ire of an employee is if you miss the opportunity of dollar-cost averaging throughout the year,” he said.
“For example, 2013 would have been a great year to argue why it’s not a good reason. The S&P 500 was up 32 percent last year, and had matches been made along the way, you would have realized the benefit of those dollars going in throughout the year. It works the other way, as well. In 2008, you were better off not having any of that money invested.
“It’s more of a psychological thought: … ‘I’ve put in my hard-earned dollars so why aren’t you, Mr. Employer, putting them in at the same time’ and take advantage of dollar-cost averaging?”
He said employers potentially can go several more months following the end of the year before making the match if they file a tax extension, which can further upset employees waiting on matches and deter some from participating in the 401(k) program at all.
“The employee may perceive the match as being less generous, and it might discourage lower-compensated workers from participating,” he said.
“It’s hard to get people, when they are making $8.50 or $9 an hour, to contribute under any condition, but then you hear the match isn’t going to come in until 20 months down the road. It’s hard to get people excited and enthusiastic when they don’t see it dropped into their account, and that could cause some problems leading to the plan not passing discrimination tests and things of that nature, which could lead to restrictions on amounts that some employees are allowed to contribute under the plan.”
But Seely did say if a company is weighing the decision of either reducing its match or going to an annual match, he supports going to an annual match.
Another potential downside of making the switch to annual contributions is how employees and prospective employees view the benefits package the company is offering. Seely said they generally view an annual match as less generous regardless of whether it is or isn’t.
“You have to be a little careful in terms of what you are doing if you are in a competitive environment, competing for quality people, and the benefit package is influencing an employee to go to work for you versus somebody else. … It is certainly a detraction to an employee if they have those last-day rules.”
Seely said companies are not likely to see any major administrative savings from switching to an annual contribution, but he did say not implementing last-day employment rules are likely to result in added work for a company’s human resources department.
“It doesn’t save the employer any money going to an annual match versus payroll, other than maybe you have your payroll specialist in a company having to utilize man hours to allocating dollars on a match with each payroll versus just doing it once a year,” he said. “The third-party administrator is not going to charge the plan sponsor any more money or have any savings if you are doing it once a year versus payroll.”
Both Seely and Lyon agreed companies should be diligent when considering annual contributions.
“I think if you have a conversation proactively and you are careful about how you talk about it, it doesn’t have to be viewed as a negative,” Lyon said.
Lyon said while she is hearing from several clients who are interested in learning more about making annual contributions, she doesn’t expect a large number to make the switch.
“I think what has changed isn’t so much with people’s practices yet, just that the conversation now includes this — when we are going to try and manage costs, this is something we might do,” she said.