Normally, companies reward ambitious and productive employees. After all, these employees make their employers lots of money. In this case, though, it’s the reverse. Many “on the ball” retirement plan savers are being penalized by unknowingly missing out on thousands of employer matching dollars.
The Retirement Plan Employer Match
Most employers contribute to their employees’ retirement plans in an effort to encourage participation. According to a Vanguard analysis of about 1,900 qualified plans and more than 3.6 million participants, 94% of plans offer an employer contribution. This employer contribution can come in several forms – including matching contributions & non-matching contributions. With employer matching contributions, employees contribute money from their paycheck and, as a result, receive some form of “match” from their employer. The most common type is the “% of pay” match. For example, your employer might match employee contributions dollar for dollar up to 5% of compensation. So if you make $10,000 and contribute 5% ($500), your employer then matches that $500. There are many variations but the gist is that employees contribute and employers match those contributions up to a certain amount (based on the plan formula). Non-matching contributions are also pretty self explanatory on the surface. Unlike matching, these employer contributions are most commonly structured as profit-sharing contributions. Companies typically make these profit-sharing contributions annually based upon a wide range of factors (not including matching employee contributions). Against popular belief, profit sharing contributions can be totally independent of company profits. The key consideration for employees is how your specific employer determines it’s contribution/match. With non-matching contributions, the employer contributions are not going to change based upon how aggressively employees fund their retirement plans. It is what it is. With matching contributions, though, it’s a totally different story.
How Matching Contributions Technically Work
“It depends on the terms of the plan document. Typically matching contributions are calculated on a payroll basis,” sais Michael Marx, CEO of Benefits Administrators, a Lexington KY based TPA firm specializing in Retirement Plan Design and Administration. W-2 employees are paid each payroll period and employer matching is based upon the same pay-period time frame.
How Ambitious Employees Miss Out
So what’s the big deal? Well, for company partners, sole proprietors and members it’s not a big deal. In those cases, matching is typically determined on an annual pay-period basis. But let’s consider an example of a proactive employee who maxes our their retirement plan sometime before the end of the year. This employee’s matching is determined on a monthly (per pay-period) basis. Let’s assume this employee has a salary of $250,000/yr and wants to max out their 401k as quickly as possible. They decide on 15% contributions which should max it out around mid year. Now here’s the kicker with employer matching…technically, the employee must make a contribution during that payroll period to receive the match. Therefore, this employee will miss out on half the year’s employer matching contributions. Here is how this would look over the 12 month period:
How To Avoid This Going Forward
The good news is, for most, it’s an easy fix. Ideally, your company allows for unlimited changes to employee contribution elections AND offers a dollar amount choice on contributions per period (versus a % of pay – it’s harder to be exact when you can only elect a %). If you are fortunate enough to work for a company like this, your next step is easy. If it’s the first day of the year, simply take the annual employee 401k maximum and divide it by the number of pay periods you have. Make that your per pay-period election. If you’re already partially through the year, take the annual 401k max ($18,000 for 2016) and subtract your year to date 401k contributions. Take this number and divide it by the remaining number of pay periods. You can see the resulting calculation below.
Implications For Plan Fiduciaries
What’s interesting about all this is that employers must act as fiduciaries to their 401k plans. This means they must always act in the best interest of plan participants. If a plan document is designed to allow for this to occur, is it truly in the best interest of the participants?