Connections for Success



Is Your Plan’s Matching Contribution Formula Delivering Results?
James Quaid

Offering matching contributions under a 401(k) plan can serve two purposes: 1) Provide a valuable benefit to your employees; and 2) Encourage plan participants to play a meaningful role in preparing for their own retirements. The trick is to do both in a way that is affordable for both you and your employees. How can your company best perform that balancing act?

Fixed matching

One approach that appears to be declining in popularity among smaller plan sponsors is the fixed-match formula, though its prevalence among larger plans is holding steady. A fixed match up to a limit can be motivational — or not — to participants, depending on its structure.

The fixed approach stands in contrast to graded matching formulas. In a graded-match formula, the match might be dollar-for-dollar up to a percentage-of-income threshold (such as 3%) and a 50-cent (or some other amount) match on the dollar on a higher tier of the participant’s total contribution level (for instance, up to 6%).

According to the Plan Sponsor Council of America’s (PSCA’s) 63rd Annual Survey of Profit Sharing and 401(k) Plans, slightly more than half (51%) of 401(k) plans with fewer than 50 participants use a fixed-match formula. That is down from 73% two years prior. The prevalence of fixed-match formulas has remained relatively constant among larger plans. According to the survey, the combined average of all plans surveyed was 69% with fixed formulas and 31% with graded matching formulas.

Stretch matching

The good news/bad news about the efficacy of fixed-match formulas as participant motivators concerns the “stretch-match” concept. A stretch-match design could, for example, be a 50% match on up to 8% of deferrals, in lieu of a dollar-for-dollar match on the first 4%. The maximum potential employer outlay per participant is the same under both approaches: 4% of compensation.

The theory behind the stretch match, the validity of which has recently come under challenge, is that employees will be motivated to set aside more of their own earnings than they otherwise would have, such as 8% instead of 4%, in this example, assuming that they are motivated to defer as much of their own compensation as will be matched.

For instance, under this theory, a participant earning $40,000 would wind up with only 8% ($3,200) of his compensation added to his 401(k) plan balance a year with the 100% match formula, versus 12% ($4,800) under the stretch-match arrangement.

But does it actually pan out that way? A Vanguard study, Stretching the Match: Unintended Effects on Plan Contributions, suggests it often does not. The study found that higher match thresholds had lower plan participation and contribution rates, while higher match values had higher participation and employee contribution rates.

Effects of auto-enrollment

Vanguard’s study focused on non-highly compensated participants (and eligible non-participants) of 401(k) plans that did not auto-enroll participants. Plans with auto-enrollment features were not analyzed because they “have a strong effect on participant behaviors” that would skew the study results, according to its author. Many studies show that larger plans use auto-enrollment in much larger numbers.

The report concluded that “seemingly counterintuitively, plan sponsors with voluntary enrollment plans seeking to raise plan contributions should consider designs with 100% match formulas.”

The report also highlighted the positive impact of auto-enrollment, based on other studies. “Our research shows that higher initial default deferral rates in automatic enrollment plan designs are the most effective way to raise employee-elective deferral rates,” it concluded.

Related Read: The Pros and Cons of Allowing New Employees to Enroll in Your 401(k) Plan Immediately

What is the answer?

Is stretch matching along with auto-enrollment the answer for your 401(k) plan? Contact your benefits specialist to run the numbers.

For more information, contact James Quaid at [email protected], or call him at 312.670.7444. Visit to learn more about our Employee Benefit Plans Services.

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