Why do companies match 401K contributions?

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills
Topic Author
d_green
Posts: 102
Joined: Sun Feb 15, 2015 2:35 pm

Why do companies match 401K contributions?

Post by d_green » Thu Feb 19, 2015 9:11 pm

My company recently changed their 401K matching policy - making it somewhat more generous. It got me thinking about why some companies match portions of their employee's 401K contributions.

I don't quite understand why they are interested in incentivizing their employees to save more of their salary. Employers have a certain amount of funds they spend on employee compensation. If employees save more, it costs the company more. If they save less, it costs the company less. From the business's perspective, wouldn't they be better off if all of their employees were spendthrifts and didn't save anything at all in their 401K's?

I understand how raises and performance bonuses help incentivize employees to work harder. But the compensation from a 401K match does not align with employee performance. You could have the worst employee saving to get the max match while the best employee not save and get no match at all.

Does making larger contributions to my 401K help my company at all? Is it to their benefit to have more assets overall in the company 401K plan? These are just things that a few of my co-workers and I were curious about. Thanks

pa7VQbb1kTkj1eLn3spK
Posts: 46
Joined: Sun Jan 26, 2014 2:05 pm

Re: Why do companies match 401K contributions?

Post by pa7VQbb1kTkj1eLn3spK » Thu Feb 19, 2015 9:16 pm

It's used as a benefit just like medical/dental, vacation, etc. If Company A and Company B offered you the same salary, but Company A offered 401k matching, which company would you choose?

User avatar
gnosis
Posts: 347
Joined: Wed Aug 13, 2008 9:05 pm

Re: Why do companies match 401K contributions?

Post by gnosis » Thu Feb 19, 2015 9:16 pm

Found your question in an older thread, so this should be helpful: http://www.bogleheads.org/forum/viewtop ... &p=1454364

A quick Google search gave me this answer to your question as well: http://www.investopedia.com/ask/answers ... s-401k.asp
Last edited by gnosis on Thu Feb 19, 2015 10:03 pm, edited 1 time in total.

User avatar
FelixTheCat
Posts: 1692
Joined: Sat Sep 24, 2011 12:39 am

Re: Why do companies match 401K contributions?

Post by FelixTheCat » Thu Feb 19, 2015 9:18 pm

I consider 401K match part of my total compensation. For example, if a company has no match then I will request a higher salary.
Felix is a wonderful, wonderful cat.

User avatar
ray.james
Posts: 1187
Joined: Tue Jul 19, 2011 4:08 am

Re: Why do companies match 401K contributions?

Post by ray.james » Thu Feb 19, 2015 9:19 pm

Dollar for dollar, the expenditure is same for company.

If the same 1% increase is given as salary raise, the employee only receives a portion after all taxes. Once the basic needs are met, people would love to have 401k matching/education benefit etc so that these are paid by company pre-tax. Because the value compounds tax free for years.

edit: Pre-tax above is from the employee perspective.
When in doubt, http://www.bogleheads.org/forum/viewtopic.php?f=1&t=79939

User avatar
tainted-meat
Posts: 773
Joined: Tue Dec 20, 2011 9:35 pm
Location: Kentucky

Re: Why do companies match 401K contributions?

Post by tainted-meat » Thu Feb 19, 2015 9:20 pm

I think one reason they match is so that more people will contribute and they can maintain a safe harbor plan. This allows the highly compensated employees (HCE) to contribute the full amount that the IRS allows to a 401k type plan.

https://www.sharebuilder401k.com/safe-harbor.aspx
Last edited by tainted-meat on Thu Feb 19, 2015 9:21 pm, edited 1 time in total.

User avatar
CABob
Posts: 4791
Joined: Sun Feb 25, 2007 8:55 pm
Location: Southern California

Re: Why do companies match 401K contributions?

Post by CABob » Thu Feb 19, 2015 9:21 pm

I don't believe there is any financial advantage for a company's contribution to a retirement plan. But, for that matter there is no advantage to giving a salary raise to an employee. They are all just a cost of doing business and how they choose to deploy those costs. Obviously it they did not pay a reasonable salary and provide reasonable salary increases they would have trouble finding employees willing to work for them. Similarly, a high matching plan make employment more attractive and better and more prospective employees will be interested in working for them.
Bob

Gill
Posts: 5897
Joined: Sun Mar 04, 2007 8:38 pm
Location: Florida

Re: Why do companies match 401K contributions?

Post by Gill » Thu Feb 19, 2015 9:23 pm

tainted-meat wrote:I think one reason they match is so that more people will contribute and they can maintain a safe harbor plan. This allows the highly compensated employees (HCE) to contribute the full amount that the IRS allows to a 401k type plan.
This is the real reason. All others are secondary.
Gill
Cost basis is redundant. One has a basis in an investment | One advises and gives advice | One should follow the principle of investing one's principal

johnubc
Posts: 744
Joined: Wed Jan 06, 2010 6:54 am

Re: Why do companies match 401K contributions?

Post by johnubc » Thu Feb 19, 2015 9:25 pm

There are many benefits that employers provide for employees for a few (not limited to) reasons -

Employee Retention
Employee Attraction
Employee Satisfaction
No FICA match on the match

Yes it does cost employers money if employees participate, but pensions cost more money.
401K. 401k Match. Paid Sick, Vacation, Personal time. Dental, vision. Healthcare until ACA. College Reimbursement, etc. It is all part of your total compensation package.

johnubc
Posts: 744
Joined: Wed Jan 06, 2010 6:54 am

Re: Why do companies match 401K contributions?

Post by johnubc » Thu Feb 19, 2015 9:27 pm

Gill wrote:
tainted-meat wrote:I think one reason they match is so that more people will contribute and they can maintain a safe harbor plan. This allows the highly compensated employees (HCE) to contribute the full amount that the IRS allows to a 401k type plan.
This is the real reason. All others are secondary.
Gill
Do you have any sources of data to validate?

User avatar
nisiprius
Advisory Board
Posts: 39800
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Why do companies match 401K contributions?

Post by nisiprius » Thu Feb 19, 2015 9:38 pm

Gill wrote:
tainted-meat wrote:I think one reason they match is so that more people will contribute and they can maintain a safe harbor plan. This allows the highly compensated employees (HCE) to contribute the full amount that the IRS allows to a 401k type plan.
This is the real reason. All others are secondary. Gill
I think so, too.

I got to see it in action. I was an HCE maxing out my 401(k). My employer eliminated their already stingy match. I didn't realize it would have the secondary effect of causing participation to drop, and the next year the IRS applied their formula, said participation was too low, retroactively cut the maximum HCEs could contribute, and I got a check in the mail returning some of my contribution and creating a nuisance in doing my taxes for the next two years.

The intent of the IRS rule is to motivate a company to make good-faith efforts to make sure the 401(k) is a widely-used benefit, not just a perk for the highly paid.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

Grt2bOutdoors
Posts: 21801
Joined: Thu Apr 05, 2007 8:20 pm
Location: New York

Re: Why do companies match 401K contributions?

Post by Grt2bOutdoors » Thu Feb 19, 2015 9:44 pm

Gill wrote:
tainted-meat wrote:I think one reason they match is so that more people will contribute and they can maintain a safe harbor plan. This allows the highly compensated employees (HCE) to contribute the full amount that the IRS allows to a 401k type plan.
This is the real reason. All others are secondary.
Gill
I agree with you. Management is in it for themselves. :twisted: But seriously, I do agree with you.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

dhodson
Posts: 4117
Joined: Mon May 24, 2010 3:03 pm

Re: Why do companies match 401K contributions?

Post by dhodson » Thu Feb 19, 2015 9:48 pm

As mentioned, it allows the employer to save. There can be vesting schedules to retain employees.

Gill
Posts: 5897
Joined: Sun Mar 04, 2007 8:38 pm
Location: Florida

Re: Why do companies match 401K contributions?

Post by Gill » Thu Feb 19, 2015 9:49 pm

johnubc wrote:Do you have any sources of data to validate?
I don't need to cite any authority. All it takes is to be familiar with the IRS rules on these plans. If the lower paid employees don't contribute there are limits on participation by higher paid employees. Who do you think is more important to most companies? Also, I rely on my 35 years of experience managing these plans and advising corporations on implementing them.
Gill
Cost basis is redundant. One has a basis in an investment | One advises and gives advice | One should follow the principle of investing one's principal

sport
Posts: 8763
Joined: Tue Feb 27, 2007 3:26 pm
Location: Cleveland, OH

Re: Why do companies match 401K contributions?

Post by sport » Thu Feb 19, 2015 9:50 pm

In addition to the reasons given above, there long has been a philosophy that employers want their employees to have their minds completely on their jobs. They do not want the employees to worry about medical bills, thus health insurance. They don't want employees to worry about retirement, thus pensions. More recently, pensions have been replaced by 401k plans. etc.

Actually, it is good business for a company to offer these benefits. If they did not, they would have to pay their employees more, and since pay does not have tax privileges, they would have to pay more than the cost of the benefits.

madbrain
Posts: 5279
Joined: Thu Jun 09, 2011 5:06 pm
Location: San Jose, California

Re: Why do companies match 401K contributions?

Post by madbrain » Thu Feb 19, 2015 9:52 pm

ray.james wrote:Dollar for dollar, the expenditure is same for company.
Is it, really ?

For employees that are maxing out social security taxes, I believe you are correct.

But for employees that don't max out SS taxes, increasing their salary also increases the employer-paid portion of social-security taxes, but a 401k match in the same amount would not.

User avatar
DonCamillo
Posts: 1033
Joined: Tue Nov 26, 2013 10:27 pm
Location: Northern New Jersey

Re: Why do companies match 401K contributions?

Post by DonCamillo » Thu Feb 19, 2015 9:56 pm

d_green wrote: Does making larger contributions to my 401K help my company at all? Is it to their benefit to have more assets overall in the company 401K plan? These are just things that a few of my co-workers and I were curious about. Thanks
I believe that you are thinking from the standpoint of an employee, not that of an employer. Most companies have some employees that are easy to replace and others that are quite valuable. For the easy to replace employees, it might make sense to pay as little as possible, although hiring a replacement can still cost the company half a year's salary. For the most valuable employees retention is a major concern. For the past ten years, I have been contributing a gross margin that is five times my total salary and benefits. I have already announced that I plan to retire in two years. They are recruiting three people to replace me, and due to the shortage of people with the right qualifications, each of them will be paid at least as much as I am making. Salary does not motivate me at all. The only reason I agreed to stay for a couple more years was for fringe benefits, medical, dental and retirement.

I founded three companies in my younger days. In all of them the most important concern was hiring and keeping key people. You do whatever you have to do to get them and keep them. And it is true that the IRS limits a company's ability to reward highly compensated employees without some consideration for everyone else.
Les vieillards aiment à donner de bons préceptes, pour se consoler de n'être plus en état de donner de mauvais exemples. | (François, duc de La Rochefoucauld, maxim 93)

User avatar
Watty
Posts: 18156
Joined: Wed Oct 10, 2007 3:55 pm

Re: Why do companies match 401K contributions?

Post by Watty » Thu Feb 19, 2015 10:06 pm

Another factor is that often the 401k match is not fully vested for five years which means that;

1) The company gets back any unvested match when an employee leaves.

2) It may reduce turnover some since some employees will have an incentive to stay around long enough to get the match vested.


Historical factors may also come into play, my 401k match started when the company discontinued the traditional pension plan.

toofache32
Posts: 1930
Joined: Sun Mar 04, 2012 6:30 pm

Re: Why do companies match 401K contributions?

Post by toofache32 » Thu Feb 19, 2015 11:39 pm

Grt2bOutdoors wrote:
Gill wrote:
tainted-meat wrote:I think one reason they match is so that more people will contribute and they can maintain a safe harbor plan. This allows the highly compensated employees (HCE) to contribute the full amount that the IRS allows to a 401k type plan.
This is the real reason. All others are secondary.
Gill
I agree with you. Management is in it for themselves. :twisted: But seriously, I do agree with you.
Management is in it for themselves??? You say this like you are actually surprised. Who else are they supposed to be "in it" for? We are ALL "in it" for ourselves. Why do you go to work every day? Is it to enrich the lives of others? Of course not....you go to work each day for the same reason "the management" goes to work. The most interesting part is that this is one of the few areas where "management" can do something for themselves that also helps others, yet others still complain about it.

johnubc
Posts: 744
Joined: Wed Jan 06, 2010 6:54 am

Re: Why do companies match 401K contributions?

Post by johnubc » Fri Feb 20, 2015 6:50 am

Gill wrote:
johnubc wrote:Do you have any sources of data to validate?
I don't need to cite any authority.
Thank you for your opinion. True, you do not need to cite any authority. I am a HCE and have been affected by low participation - and we found that increasing the match did not get much traction - which is why I would like to see some data around it instead of an opinion. With data I can get my already generous match increased. In the mean time we go with a non-qualifed deferred compensation plan to make up for the reduced contribution.

DFrank
Posts: 474
Joined: Thu Mar 20, 2014 10:44 pm
Location: North Idaho

Re: Why do companies match 401K contributions?

Post by DFrank » Fri Feb 20, 2015 9:37 am

I suspect many companies look at 401k match as an investment in the value proposition they make to attract and retain quality employees. In the past they might have made a similar investment in a defined benefit pension plan, but those have become too costly and risky, so they have redirected those funds into 401k matching programs. It could be that some of that motivation is to encourage lower level employees to contribute thereby protecting the participation of HCE, but in the end it's still all about attracting and retaining employees. If they didn't need to offer these programs for that objective they would quickly go the way of the dodo bird.

At my megacorp our DB pension plan was frozen about 8 years ago. We were given about 3 years notice of the change, and in addition to an already generous 401k matching program they now make a separate contribution to our 401k account based on age and years of service. That contribution tops out at 6% of pay.
Dave

User avatar
JDCarpenter
Posts: 1404
Joined: Tue Sep 09, 2014 2:42 pm

Re: Why do companies match 401K contributions?

Post by JDCarpenter » Fri Feb 20, 2015 10:12 am

Watty wrote:Another factor is that often the 401k match is not fully vested for five years which means that;

1) The company gets back any unvested match when an employee leaves.

2) It may reduce turnover some since some employees will have an incentive to stay around long enough to get the match vested.


Historical factors may also come into play, my 401k match started when the company discontinued the traditional pension plan.
But as noted by others, often the match is there to keep HCE opportunities high. If doing so via a safeharbor, the match will have to vest immediately (at least in part). (Will defer to those with more up-to-date knowledge as to the details of this.)
Edit Signature

epitomist
Posts: 240
Joined: Mon Jul 21, 2014 2:00 pm

Re: Why do companies match 401K contributions?

Post by epitomist » Fri Feb 20, 2015 11:25 am

johnubc wrote:
Gill wrote:
johnubc wrote:Do you have any sources of data to validate?
I don't need to cite any authority.
Thank you for your opinion. True, you do not need to cite any authority. I am a HCE and have been affected by low participation - and we found that increasing the match did not get much traction - which is why I would like to see some data around it instead of an opinion. With data I can get my already generous match increased. In the mean time we go with a non-qualifed deferred compensation plan to make up for the reduced contribution.
Gotta love it when someone says the sky is blue someone asks for a link proving it. Gee, what a logical stretch... paying people money to participate in a 401k increases participation in a 401k.

Speaking of not providing data, "we found that increasing the match did not get much traction" is not data. What was the match before the change and what was it after? What was the participation rate before and after? That would be data.

Anyway, increasing 401k participation rate is not rocket science:

http://www.401khelpcenter.com/increase_ ... ation.html

The #1 legal way to do it is to make 401k opt-out instead of opt-in. That is automatic enrollment for all employees with instructions on how to opt-out if they want to.

gd
Posts: 1590
Joined: Sun Nov 15, 2009 8:35 am
Location: MA, USA

Re: Why do companies match 401K contributions?

Post by gd » Fri Feb 20, 2015 11:52 am

Allow me to summarize the possibilities so far:
1) HCEs make the self-interested decision to match non-HCE contributions so as to boost contributions by non-HCEs, with the ultimate goal of boosting HCE rewards.
2) As a recruitment and retention benefit.
3) Because it's a decent thing to do.

I suggest 1 & 2 depend on circumstances, are not mutually exclusive, and likely unknowable by outsiders to the decision if not the deciders themselves. 3 is less common.

inbox788
Posts: 6699
Joined: Thu Mar 15, 2012 5:24 pm

Re: Why do companies match 401K contributions?

Post by inbox788 » Fri Feb 20, 2015 12:37 pm

nisiprius wrote:
Gill wrote:
tainted-meat wrote:I think one reason they match is so that more people will contribute and they can maintain a safe harbor plan. This allows the highly compensated employees (HCE) to contribute the full amount that the IRS allows to a 401k type plan.
This is the real reason. All others are secondary. Gill
I think so, too.

I got to see it in action. I was an HCE maxing out my 401(k). My employer eliminated their already stingy match. I didn't realize it would have the secondary effect of causing participation to drop, and the next year the IRS applied their formula, said participation was too low, retroactively cut the maximum HCEs could contribute, and I got a check in the mail returning some of my contribution and creating a nuisance in doing my taxes for the next two years.

The intent of the IRS rule is to motivate a company to make good-faith efforts to make sure the 401(k) is a widely-used benefit, not just a perk for the highly paid.
How much can HCE get in a year? The limit to defer taxes is $18,000 in 2015. That includes the matching, right? Isn't anything beyond that double taxed?

http://www.irs.gov/Retirement-Plans/Pla ... ion-Limits

If matching doesn't have some offsetting costs, it's a lot of money to spend just for a small bonus. It seems simpler and more profitable to just take the matching funds and redistribute it all for much bigger bonuses.

It's a little like saying people donate to charity because of the tax deduction. While it may help promote giving, there is still a net cost.

User avatar
JDCarpenter
Posts: 1404
Joined: Tue Sep 09, 2014 2:42 pm

Re: Why do companies match 401K contributions?

Post by JDCarpenter » Fri Feb 20, 2015 12:52 pm

inbox788 wrote:...How much can HCE get in a year? The limit to defer taxes is $18,000 in 2015. That includes the matching, right? Isn't anything beyond that double taxed?

http://www.irs.gov/Retirement-Plans/Pla ... ion-Limits

If matching doesn't have some offsetting costs, it's a lot of money to spend just for a small bonus. It seems simpler and more profitable to just take the matching funds and redistribute it all for much bigger bonuses.

It's a little like saying people donate to charity because of the tax deduction. While it may help promote giving, there is still a net cost.
Much more than 18,000, even without the catch-up contributions:
The annual additions paid to a participant’s account cannot exceed the lesser of:
100% of the participant's compensation, or

$52,000 ($57,500 including catch-up contributions) for 2014 ($53,000, or $59,000 including catch-up contributions for 2015).
http://www.irs.gov/Retirement-Plans/Pla ... ion-Limits ("Overall Limits" section, about 60% of the way down)

In, for example, a medical group, the HCEs have a lot of incentive. The safeharbor contribution doesn't cost that much.
Edit Signature

Dulocracy
Posts: 2303
Joined: Wed Feb 27, 2013 1:03 pm
Location: Atlanta, GA

Re: Why do companies match 401K contributions?

Post by Dulocracy » Fri Feb 20, 2015 1:00 pm

At my firm, we do it for employee attraction and retention. Our 401k is full of DFA and Vanguard funds. The costs of the 401k are paid by the firm, and the adviser we have available is paid by the firm. The only cost to the employees for their 401k is the actual expense ratio found on Morningstar. We offer the match to encourage our employees to put money aside for themselves, but also because we want good employees. Also, employees who understand the value of what we do are likely to be more intelligent. If someone does not see the value in a company paying the fees for the 401k directly, that is not the attorney I want working for me. In the end, paying these fees out of our pockets cost us MUCH more than the partners would pay out of our own accounts. By setting it up this way, we are directly reducing our disbursement checks at the end of the year by a good chunk of change. I would be MUCH better off personally by allowing the employees to pay their own fees by a percentage than having the firm pay these fees for everyone. Similarly, we offer a match for the same reason. We do care about our employees, and we want to be a great place to work.

Full disclosure, we do have a safe-harbor plan, but we do more than is required to have the safe harbor provision. If that was all that we cared about, we would be able to do so at a much lower cost to ourselves and higher cost to the employees.

For those that think management is only out for management, realize that management is made up of people just like you. Someone who would be only after their own interests may think that management is similarly only after management's interests. In actuality, our 401k committee is open to all employees for discussion, and we act with the idea of doing the best that we can for the employee. That is our guiding principal. I have a feeling that many other companies have similar ideas about providing benefit to the employees. Sadly, there are problems that turn up (like high expense ratios). I would be willing to bet that these problems are more often about lack of understanding of funds, plans, and expenses, rather than an evil desire to have high fees for all involved (remember, management also has to use the same plan). Luckily, the head of the 401k committee at my firm is a member of this website (that would be me).
I'm not a financial professional. Post is info only & not legal advice. No attorney-client relationship exists with reader. Scrutinize my ideas as if you spoke with a guy at a bar. I may be wrong.

itstoomuch
Posts: 5343
Joined: Mon Dec 15, 2014 12:17 pm
Location: midValley OR

Re: Why do companies match 401K contributions?

Post by itstoomuch » Fri Feb 20, 2015 1:03 pm

+1 to tainted-meat
DS works for a tech company. Lots of well paid techies.
Until this year, this tech company did not have match program. I advised DS to stay with taxable and Roth, with a minimal amount to 401k. Good ISO's but he has to accumulated the purchase exercise costs.

This year company instituted 401k match. It is now a retention and recruitment tool. :annoyed

Isn't a company's 401k match, a tax deduction to them? :?:
Last edited by itstoomuch on Fri Feb 20, 2015 1:14 pm, edited 1 time in total.
Rev012718; 4 Incm stream buckets: SS+pension; dfr'd GLWB VA & FI anntys, by time & $$ laddered; Discretionary; Rentals. LTCi. Own, not asset. Tax TBT%. Early SS. FundRatio (FR) >1.1 67/70yo

User avatar
bnwest
Posts: 168
Joined: Thu Mar 01, 2007 7:25 pm
Location: durham, north carolina

Re: Why do companies match 401K contributions?

Post by bnwest » Fri Feb 20, 2015 1:03 pm

IIRC 401Ks *have* to be part of a Profit Sharing Plan. Companies get tax deductions for their contributions if the PS plan is qualified. To be qualified PS plan, the company has to make distributions into it, i.e. the company has to share the profits. There are several formulas to calculate qualification, but following the Safe Harbor rules is the easy way to stay qualified.

inbox788
Posts: 6699
Joined: Thu Mar 15, 2012 5:24 pm

Re: Why do companies match 401K contributions?

Post by inbox788 » Fri Feb 20, 2015 1:53 pm

itstoomuch wrote:Isn't a company's 401k match, a tax deduction to them? :?:
Isn't an employee salary a tax deduction for the company? Is there any additional financial/tax benefit for the company?

Participation in matching isn't 100%, so it costs a company less than salary increase. Also taking away a match doesn't feel like cutting salary, though it's the same for folks that are maxing out.
JDCarpenter wrote:
$52,000 ($57,500 including catch-up contributions) for 2014 ($53,000, or $59,000 including catch-up contributions for 2015).
http://www.irs.gov/Retirement-Plans/Pla ... ion-Limits ("Overall Limits" section, about 60% of the way down)

In, for example, a medical group, the HCEs have a lot of incentive. The safeharbor contribution doesn't cost that much.
Again, isn't the amount above $18,000 taxable? So what's the difference between a $52k bonus and a $52k match, other than perception?

User avatar
JDCarpenter
Posts: 1404
Joined: Tue Sep 09, 2014 2:42 pm

Re: Why do companies match 401K contributions?

Post by JDCarpenter » Fri Feb 20, 2015 2:12 pm

inbox788 wrote:... Again, isn't the amount above $18,000 taxable? So what's the difference between a $52k bonus and a $52k match, other than perception?
Employer can deduct its contribution/match/sharing, so it is not taxed. See IRC sec. 404 http://www.law.cornell.edu/uscode/text/26/404

From personal knowledge since 1990, not taxable to employee either (until withdrawal, of course).

For an accessible discussion of both ends of the transaction, see http://www.azzad.net/pages/profitsharing.aspx and http://nicholaspension.com/401%28k%29Overview.pdf
Edit Signature

User avatar
House Blend
Posts: 4657
Joined: Fri May 04, 2007 1:02 pm

Re: Why do companies match 401K contributions?

Post by House Blend » Fri Feb 20, 2015 2:12 pm

In academia, there's another reason: the worst nightmare of a dean or provost is a a faculty of grumpy old (wo)men with tenure who can't afford to retire.

Topic Author
d_green
Posts: 102
Joined: Sun Feb 15, 2015 2:35 pm

Re: Why do companies match 401K contributions?

Post by d_green » Fri Feb 20, 2015 2:17 pm

Thanks for all the responses. I'm learning a lot about 401K plans from this thread.

One issue I am not totally clear about is the cost to the employer of offering a 401K plan with no match. In my prior job, the company offered no 401K plan period, so I just maxed out my contributions to my IRA. I would have so badly liked to have more space for tax deferred-savings (even though the employer offered no match.)

Is offering a 401K plan to employees with no match a significant cost to an employer? Even if the employees had to pay some small administrative fee to participate in the 401K, I would have probably participated. Having that $18K space for tax deferred savings would have been very helpful.

Thanks
Last edited by d_green on Fri Feb 20, 2015 2:19 pm, edited 1 time in total.

Andyrunner
Posts: 758
Joined: Thu May 03, 2012 9:14 am

Re: Why do companies match 401K contributions?

Post by Andyrunner » Fri Feb 20, 2015 2:18 pm

My company recently added a 401k match. They did this because they redid the pension calculation, so it put less burden on the company but still kept the employee happy with a new match.

inbox788
Posts: 6699
Joined: Thu Mar 15, 2012 5:24 pm

Re: Why do companies match 401K contributions?

Post by inbox788 » Fri Feb 20, 2015 2:28 pm

Andyrunner wrote:My company recently added a 401k match. They did this because they redid the pension calculation, so it put less burden on the company but still kept the employee happy with a new match.
That I understand. Shifting from a defined benefit plan (unknown costs) to a defined contribution plan (401k) helps companies limit liabilities. Simply going from pension to 401k is probably a downgrade, but with some matching, the expected result may be beneficial if all goes well or historic. One can take greater risk in a 401k than the company does with a pension.

bhsince87
Posts: 2642
Joined: Thu Oct 03, 2013 1:08 pm

Re: Why do companies match 401K contributions?

Post by bhsince87 » Fri Feb 20, 2015 2:36 pm

d_green wrote:Thanks for all the responses. I'm learning a lot about 401K plans from this thread.

One issue I am not totally clear about is the cost to the employer of offering a 401K plan with no match. In my prior job, the company offered no 401K plan period, so I just maxed out my contributions to my IRA. I would have so badly liked to have more space for tax deferred-savings (even though the employer offered no match.)

Is offering a 401K plan to employees with no match a significant cost to an employer? Even if the employees had to pay some small administrative fee to participate in the 401K, I would have probably participated. Having that $18K space for tax deferred savings would have been very helpful.

Thanks
Yes, there would be costs with any 401k. And legal responsibilities. Whether those are significant or not would vary from firm to firm.

And you seem to be answering one of your own questions. :) Having access to a 401k, with a match or not, would be appealing to you. And also to many other folks. So it is absolutely an attraction/retention tool as well.
"If ye love wealth better than liberty, the tranquility of servitude better than the animating contest of freedom, go home from us in peace." Samuel Adams

inbox788
Posts: 6699
Joined: Thu Mar 15, 2012 5:24 pm

Re: Why do companies match 401K contributions?

Post by inbox788 » Fri Feb 20, 2015 2:47 pm

JDCarpenter wrote:
inbox788 wrote:... Again, isn't the amount above $18,000 taxable? So what's the difference between a $52k bonus and a $52k match, other than perception?
Employer can deduct its contribution/match/sharing, so it is not taxed. See IRC sec. 404 http://www.law.cornell.edu/uscode/text/26/404

From personal knowledge since 1990, not taxable to employee either (until withdrawal, of course).

For an accessible discussion of both ends of the transaction, see http://www.azzad.net/pages/profitsharing.aspx and http://nicholaspension.com/401%28k%29Overview.pdf
I still don't see the difference between a bonus and a 401k plan. Let's say I own a small business with 10 employees. At the end of the year, I have $100,000 pre-tax company profit. So I give myself a $50,000 bonus and each of my employees a $5,000 bonus. So the company now has zero profit, right? Or I can create a 401k plan and give myself $50,000 and each of my employees contribute to their 401k so the get 100% matching. Isn't the profit to the company the same either way?

For the employee, isn't an IRA simpler than contributing to 401k for match?

Now as the owner, I can just pay myself $100k bonus instead of sharing with employees. Financially, I think I'm better off.

https://investor.vanguard.com/what-we-o ... Link=facet

If there wasn't some other benefit, and all I was looking out for was myself, I could just take the whole cash and do something like a SEP IRA for myself.

https://investor.vanguard.com/what-we-o ... Link=facet

The costs of some of these plans are probably modest, but that's on top of the matching costs itself.

So I think that companies wouldn't offer matching if they didn't need to, and there's some competitive or comparative pressure to use up valuable company cash and time.

User avatar
JDCarpenter
Posts: 1404
Joined: Tue Sep 09, 2014 2:42 pm

Re: Why do companies match 401K contributions?

Post by JDCarpenter » Fri Feb 20, 2015 2:56 pm

inbox788 wrote:...I still don't see the difference between a bonus and a 401k plan. Let's say I own a small business with 10 employees. At the end of the year, I have $100,000 pre-tax company profit. So I give myself a $50,000 bonus and each of my employees a $5,000 bonus. So the company now has zero profit, right? Or I can create a 401k plan and give myself $50,000 and each of my employees contribute to their 401k so the get 100% matching. Isn't the profit to the company the same either way?

For the employee, isn't an IRA simpler than contributing to 401k for match?

Now as the owner, I can just pay myself $100k bonus instead of sharing with employees. Financially, I think I'm better off.

....
I'm going to go with what I am familiar with on this. Say you have 40 doctors, each HCE, who own the company. Say you have 120 other employees, who you make 3% of comp contributions for as a safeharbor. Now, each doctor can put away over 50K a year, tax free (avoiding 40% marginal rate). At retirement, docs can withdraw the funds at well under 40% rate (assuming that they don't work until they die, which some will). In DW's case, she will fill up 25% bracket with Roth Conversions, as opposed to the 40% marginal rate she would have paid when working. The 3% safeharbor contributions, particularly given the average income of most of the other employees, don't outweigh this spread, particularly given the tax free compounding.

I do not disagree that there are other reasons for 401ks. They can be necessary to attract and retain employees (DS and his friends likely would not have accepted non-startup jobs in silicon valley without a good plan--unless comp was sufficiently high to make up for the high state and fed rates). Nonetheless, there are real benefits for owners and HCEs in many/most situations.
Edit Signature

TheRightKost87
Posts: 289
Joined: Tue Aug 13, 2013 12:25 am
Location: Boston, MA

Re: Why do companies match 401K contributions?

Post by TheRightKost87 » Fri Feb 20, 2015 3:25 pm

The limit for tax deferred is 18k for 2015. Anything after that is taxed at my marginal rate, correct?

So if my employer doesn't match, and I want to contribute 25k to the 401k, can I do that (with the last 7k being taxed at my rate), and then later roll that into an IRA?

I'm really struggling with understanding how there is a 18k limit and a 53k limit, other than for employer matches. How else other than employer matches would you max to 53k, and what would happen then (is the last 35k taxed at your marginal rate, and then gains taxed as well)? I guess I'm trying to figure out why HCE don't contribute 53k to their 401ks every year and then roll it right out to an IRA (assuming there are in service distriubtions, and if not, rolling to an IRA when they eventually leave the employer)
"The problem with diversification is that it works, whether or not we want it to"

User avatar
JDCarpenter
Posts: 1404
Joined: Tue Sep 09, 2014 2:42 pm

Re: Why do companies match 401K contributions?

Post by JDCarpenter » Fri Feb 20, 2015 3:52 pm

TheRightKost87 wrote:...The limit for tax deferred is 18k for 2015. Anything after that is taxed at my marginal rate, correct?

So if my employer doesn't match, and I want to contribute 25k to the 401k, can I do that (with the last 7k being taxed at my rate), and then later roll that into an IRA?

I'm really struggling with understanding how there is a 18k limit and a 53k limit, other than for employer matches. How else other than employer matches would you max to 53k, and what would happen then (is the last 35k taxed at your marginal rate, and then gains taxed as well)? I guess I'm trying to figure out why HCE don't contribute 53k to their 401ks every year and then roll it right out to an IRA (assuming there are in service distriubtions, and if not, rolling to an IRA when they eventually leave the employer)
1. Depends on your plan. If it allows after-tax contributions, yes. But you need to look carefully to see if after-tax makes sense for you. [I don't know the rules on rollouts of after-tax.]

2. rather than employer "match," think about employer "contribution." But yes, for before-tax amounts between the employee contribution limit of 18K (before age 50) and the total limit, it would be filled by the employer. And it is not taxed at the time of contribution. Only upon withdrawal. Note that any personal after-tax contribution would reduce the headroom for employer contribution/match.
Edit Signature

User avatar
ray.james
Posts: 1187
Joined: Tue Jul 19, 2011 4:08 am

Re: Why do companies match 401K contributions?

Post by ray.james » Fri Feb 20, 2015 4:02 pm

madbrain wrote:
ray.james wrote:Dollar for dollar, the expenditure is same for company.
Is it, really ?

For employees that are maxing out social security taxes, I believe you are correct.

But for employees that don't max out SS taxes, increasing their salary also increases the employer-paid portion of social-security taxes, but a 401k match in the same amount would not.
That is interesting. Since employee pays FICA taxes, I assumed employer would do too. I believe this is still viewed as earned income?
When in doubt, http://www.bogleheads.org/forum/viewtopic.php?f=1&t=79939

inbox788
Posts: 6699
Joined: Thu Mar 15, 2012 5:24 pm

Re: Why do companies match 401K contributions?

Post by inbox788 » Fri Feb 20, 2015 5:18 pm

JDCarpenter wrote:Now, each doctor can put away over 50K a year, tax free (avoiding 40% marginal rate). At retirement, docs can withdraw the funds at well under 40% rate (assuming that they don't work until they die, which some will). In DW's case, she will fill up 25% bracket with Roth Conversions, as opposed to the 40% marginal rate she would have paid when working. The 3% safeharbor contributions, particularly given the average income of most of the other employees, don't outweigh this spread, particularly given the tax free compounding.
Thanks for the example. Now I'm seeing the difference between the limit $18k for employEE contribution vs $52k for employER. That substantially increases the tax advantaged space...and now I see why some folks are saying this is the primary reason for the plans. You've convinced me. The safe harbor clause really helps those with high HCE:other employee ratios (i.e 1:2, 1:4 vs 1:10 or 1:20 or more).

madbrain
Posts: 5279
Joined: Thu Jun 09, 2011 5:06 pm
Location: San Jose, California

Re: Why do companies match 401K contributions?

Post by madbrain » Fri Feb 20, 2015 7:20 pm

ray.james wrote:
madbrain wrote:
ray.james wrote:Dollar for dollar, the expenditure is same for company.
Is it, really ?

For employees that are maxing out social security taxes, I believe you are correct.

But for employees that don't max out SS taxes, increasing their salary also increases the employer-paid portion of social-security taxes, but a 401k match in the same amount would not.
That is interesting. Since employee pays FICA taxes, I assumed employer would do too. I believe this is still viewed as earned income?
The employee still pays FICA taxes on their elective deferrals, and therefore the employer pays their share on those too.
However, the 401k match does not show up anywhere on my W-2, so I don't believe it's earned income.
Ie. FICA taxes are not due on the match - neither employee share or employer share.

User avatar
GerryL
Posts: 2611
Joined: Fri Sep 20, 2013 11:40 pm

Re: Why do companies match 401K contributions?

Post by GerryL » Fri Feb 20, 2015 9:36 pm

johnubc wrote:
Gill wrote:
tainted-meat wrote:I think one reason they match is so that more people will contribute and they can maintain a safe harbor plan. This allows the highly compensated employees (HCE) to contribute the full amount that the IRS allows to a 401k type plan.
This is the real reason. All others are secondary.
Gill
Do you have any sources of data to validate?
You might be interested in this 2006 Frontline episode "Can you afford to retire?" (http://www.pbs.org/wgbh/pages/frontline/retirement/) As I recall, it discusses how 401Ks rose to be the retirement vessel for many Americans.

FedGuy
Posts: 1265
Joined: Sun Jul 25, 2010 3:36 pm

Re: Why do companies match 401K contributions?

Post by FedGuy » Fri Feb 20, 2015 11:19 pm

Dulocracy wrote:I would be MUCH better off personally by allowing the employees to pay their own fees by a percentage than having the firm pay these fees for everyone. Similarly, we offer a match for the same reason. We do care about our employees, and we want to be a great place to work.
You said you're a law firm? That doesn't sound like any law firm I've ever worked for. None of which paid my 401(k) fees, offered a match, or seemed to have the slightest interest in providing a great or even tolerable place to work.

mindboggling
Posts: 354
Joined: Sat Sep 06, 2014 6:35 pm
Location: Upstate NY

Re: Why do companies match 401K contributions?

Post by mindboggling » Sat Feb 21, 2015 1:51 pm

I worked for a commercial television network that was bought by a large media conglomerate. They actually cut the 401k matching in half. Guess they didn't want the peasants to have too much.

Steve
In broken mathematics, We estimate our prize, --Emily Dickinson

Lindrobe
Posts: 398
Joined: Fri Dec 26, 2014 9:35 am
Location: Mishawaka, IN

Re: Why do companies match 401K contributions?

Post by Lindrobe » Sun Feb 22, 2015 8:01 am

I am not trying to hijack this thread, but just found out this week that husband is considered HCE at his company :( He contributes 10% to his 401 and average non-HCE contribution rate is only 2.2%. He is getting over $9,000 of his 2014 contributions sent back to him. Company laughed at him when he asked them to consider safe harbor. Came searching on this forum for alternative retirement saving ideas and came across this thread.

User avatar
JamesSFO
Posts: 3234
Joined: Thu Apr 26, 2012 10:16 pm

Re: Why do companies match 401K contributions?

Post by JamesSFO » Sun Feb 22, 2015 8:27 am

Lindrobe wrote:I am not trying to hijack this thread, but just found out this week that husband is considered HCE at his company :( He contributes 10% to his 401 and average non-HCE contribution rate is only 2.2%. He is getting over $9,000 of his 2014 contributions sent back to him. Company laughed at him when he asked them to consider safe harbor. Came searching on this forum for alternative retirement saving ideas and came across this thread.
That's unfortunate. Some things your husband can do include: (backdoor) Roth IRA contributions and taxable investing.

johnubc
Posts: 744
Joined: Wed Jan 06, 2010 6:54 am

Re: Why do companies match 401K contributions?

Post by johnubc » Sun Feb 22, 2015 10:07 am

epitomist wrote: Gotta love it when someone says the sky is blue someone asks for a link proving it. Gee, what a logical stretch... paying people money to participate in a 401k increases participation in a 401k.

Speaking of not providing data, "we found that increasing the match did not get much traction" is not data. What was the match before the change and what was it after? What was the participation rate before and after? That would be data.
Yes, I asked if he had data to back up his opinion. He is entitled to his opinion - but when I go to my compensation committee and say that 'a guy on a blog said.....' I need to back it up with data. I am fine with his opinion. He does not have to cite a source. I did not offer any data. I offered a single anecdotal experience, in my opinion.

Dulocracy
Posts: 2303
Joined: Wed Feb 27, 2013 1:03 pm
Location: Atlanta, GA

Re: Why do companies match 401K contributions?

Post by Dulocracy » Tue Feb 24, 2015 5:28 pm

FedGuy wrote:
Dulocracy wrote:I would be MUCH better off personally by allowing the employees to pay their own fees by a percentage than having the firm pay these fees for everyone. Similarly, we offer a match for the same reason. We do care about our employees, and we want to be a great place to work.
You said you're a law firm? That doesn't sound like any law firm I've ever worked for. None of which paid my 401(k) fees, offered a match, or seemed to have the slightest interest in providing a great or even tolerable place to work.
Yes indeedy. Note that it is a boutique law firm that would be considered small (typically 12-15 employees, 6 of whom are attorneys). We try to keep a family atmosphere, and we want people to be secure in their future if they stay with the firm. We cut the check directly to pay for the 401k, and nothing is taken from employees' accounts for any maintenance or operating costs.
I'm not a financial professional. Post is info only & not legal advice. No attorney-client relationship exists with reader. Scrutinize my ideas as if you spoke with a guy at a bar. I may be wrong.

Post Reply