The 401(k) as Cost Reduction Target

I've been asked by several clients recently for data about the reduction or elimination of 401(k) employer matches as a cost-savings tactic.  Thanks to the recent release of a few studies, we have some up-to-the-minute information available that sheds some light not only on how prevalent this tactic is, but also a little on the outcomes driving these initiatives and some alternatives to consider first.

Recent research released by Hewitt Associates and Watson Wyatt (note that these links go to the releases themselves) provides data on the extent to which organizations are taking this particular cost reduction step:

  

While only a minority of organizations appear to have already taken the step, when you add in those that are contemplating such a move, the numbers get more significant.  A separate study by Hewitt Associates tells more about what kinds of cost savings are driving this interest.  According to Hewitt's analysis in this second study, companies can save, on average, more than $1,500 per year by suspending their 401(k) employer match (assuming an average employer match of 50 cents to the dollar for up to 6% of pay).  For the average large (U.S.) company this could be savings of $25 million a year.   For the average mid-sized business it could add up to $10 million annually, and to nearly $2 million for the average smaller company.  It's no wonder employers are tempted.

But, as the Hewitt study details, these decisions come at a high cost to employee plan participation and contribution rates and - ultimately - can significantly impact employee savings for retirement.  With this in mind, Hewitt proposes some alternative approaches that can help employers mitigate short-term cost pressures while still encouraging workers to invest wisely for retirement:

Decrease the match: The average large employer can save nearly $13 million each year by decreasing their match by half instead of suspending it entirely. This still motivates employees to continue contributing to their 401(k), even if at a lower rate.

Communicate to employees only through online means:Hewitt research shows that employers believe communication is a critical tool in helping their employees save properly for retirement, particularly during these troubled economic times. Three-quarters (75 percent) of companies are using their intranet site, 60 percent are making use of e-mail blasts, and 49 percent are using Webinars. Still, many employers use printed materials in addition to online tools to communicate with employees. By moving to online-only communication, employers can effectively reach their employees while saving money on paper costs.

Make fees transparent: Employers should take a closer look at the funds they offer in their 401(k) to ensure they do not carry high expense ratios. Hewitt research shows that additional annual expenses of 0.25 percent — the difference between the typical institutional fund and retail mutual fund portfolio — can reduce projected retirement income substantially over time. For younger employees, these higher costs can erode 401(k)-related retirement income levels by nearly 6 percent by the time these employees reach retirement age.

Comments

[Paul Weatherhead]

So many things to comment on regarding this issue! I'll start with the communications issue and send something on the other issues a little later.

It would be a grave mistake to just rely on the internet email to communicate important issues about an employee's retirement. Think of the 800,000 USPS employees where perhaps 80% to 90% don't have access to the company email system because they are fully engaged moving the mail all day. There is still a sizable population of employees that don't even have computers. So its absolutely essential when communicating with your entire workforce to use a variety of media - including the good old US Mail!

[Paul Weatherhead]

As recently as the 1980s I recall people preaching about the three-legged retirement stool - personal savings, the company pension plan, and Social Security.

Well, companies didn't like the accrual accounting of pension liabilities so there was a shift to more defined contribution plans. (Defined benefit plans seemed to have gone the way of the dodo bird!)

Then with the collapse of the stock market, both personal savings and defined contribution plans are a fraction of their previous value.

Now with companies eliminating their contributions to 401k plans, the three legged retirement stool only has one leg to stand on!

[Paul Weatherhead]

I like the idea of transparent 401k fees.

At my first employment out of college I didn't think much about the CEO of our 401k administrator being on the board of my employer; and my employer's CEO being on the board of our 401k administrator.

Thirty years later I now learn that the federal government's version of the 401k plan only charges participants 19 cents per $1,000 invested – self described by the Thrift Savings Plan as a negligible amount. Can anyone tell me how that compares with typical 401k or 403b plans?

If the federal program’s rate is truly negligible compared to 401k and 403b costs in other sectors of the economy, then maybe I should have thought more about those interlocking directorships.

[Ann Bares]

Paul:

Good thoughts. I'm no expert in 401(k) administration - just thought I'd share the info here since I am getting questions.

I would hope that the on-line communication option would only be seriously considered by organizations where all employees have some regular access to computers as part of their workday. And - again - though not ideal, I think I'd rather see an employer that believes it has to cut somewhere move to online communication rather than reducing or eliminating the match.

Certainly that three legged retirement stool is not standing very strongly these days for anybody - unfortunately.

I join you in hoping that we are seeing the bottom of this particular trend.