Most of us appreciate the benefits of 401(k) plans, and like having them as an option for retirement savings. The tax deferred nature of them is great, and garners a lot of attention. But the company match can be pretty nice too, and a great benefit!
This is why recent news of a company switching to a lump sum, end-of-year match garnered some attention from a lot of people. Apparently, per this piece in the Washington Post, this created a bit of a fuss with a lot of people. Instead of the match occurring with each paycheck, the match occurred only at the end of the year.
So, the match was not taken away. Rather, it was just distributed at different intervals. Not so bad, right?
Well, it depends on one’s perspective. Having a match is better than not having a match. So in that regard, it may not be as bad as the alternatives. However, there are a couple of problems with this:
1) Diminished Power of Compounding
On the one hand, the exact amount of money given as a match might be the same whether given with each paycheck or in a lump sum. If a person makes $100,000 annually, and gets a 3% match, basic math indicates that the match will be $3,000. The lump sum at the end of the year would be, of course, $3,000. If there are 12 monthly pay periods, as an example, there would be a $250 contribution each time.
The issue is that the money set aside earlier in the year has time to grow. For example, lets say that after the 1s pay period, the stock market increased by 20% through the rest of the year. That original $250 would end up being worth $300. This concept could apply to many of the other contributions through the year as well.
By giving the match all at once at the end of the year, the compounding effect is taken away. Thus, money could be lost. In a year with increasing stock prices, this means lost opportunity.
Now, a lump sum might end up being better in a year where stock prices plummet. But on average, stocks tend to go up most years. So paying all at once is generally not a good attribute.
2) Losing the Match if You Leave the Job
Aside from the aforementioned considerations with timing and frequency of matches, there is the issue of what happens to the match if the person leaves the job.
Now, people don’t usually join and leave companies on an exact calendar basis. If someone leaves a company before the end of the plan year (whatever that might be), the match could be lost. So, in the example above, let’s say that someone was with a company for 8 months of a year, then left. This means that if there are monthly contributions, $2,000 will have been paid out – but zero if it’s a company with an annual lump sum.
Thus, while in many cases a lump sum could be preferable, this is probably not one of those situations.
Fortunately, in the situation described in the article, the company did reverse course with the lump sum decision. Credit is deserved for the change in policy!
However, I wonder how many companies in general would feel compelled to make a change back. What is the motivation? Frankly, it would seem like there could be a fair amount of savings accruing to companies who make and keep a switch to lump sum payouts. After all, people leaving before year-end would presumably get nothing.
Think about it. If you’re interviewing for a job, would you truly turn down a really good opportunity based on the 401(k) match being given in a lump sum? Or, if you’re working for a company that makes that switch, would it compel you to job search and look elsewhere strictly based on that?
It wouldn’t be surprising to see this happen.
To me, this just looks like a situation where there is not that much downside for companies to implement this. But, there could be savings generated. If there was a wave of businesses doing this, I don’t think any one situation would stand out and create an uproar. This seems like low-hanging fruit.
My Questions for You
What would your reaction be if your employer switched the 401(k) match to a lump sum from a per-pay period contribution?
Do you think this might be the wave of the future?