Risks lurk in annual 401(k) matches

As major employers tweak their 401(k) matching contribution schedules, opting for an annual lump-sum payment rather than per pay period, advisers are calling for more conversations with their employer clients to discuss plan design and benefit restructuring.

“We're entering a key time with most employers,” said Jim O'Shaughnessy, a managing partner at Sheridan Road Financial. “A lot of it has to do with the last decade. We're having these deeper discussions with our clients on all benefits, and the primary focus is on how the retirement benefits are coordinated with other benefits.”

Some of the largest employers match on an annual basis, according to an analysis by Bloomberg, including financial services firms that have touted the importance of retirement savings. Those firms include such household names as The Charles Schwab Corp., Citigroup Inc., Morgan Stanley and JPMorgan Chase & Co.

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But advisers worry that employees who decide to switch jobs at the wrong time, thus missing the annual match, could end up denting their retirement savings. Further, there's the problem of making one lump-sum investment into the market; investors miss out on dollar-cost averaging. The S&P 500 index enjoyed a sharp 30% gain over the course of 2013, so investors who bought stocks at the end of the year had already missed out on the rally through the year.

“The lump sum match can put the participant at a disadvantage if the market is at the wrong place in the wrong time,” said Craig Morningstar, chief operating officer at Dynamic Wealth Advisors. “This seems like one of those changes that works to decrease outcomes for the participant.”

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Anecdotally, service providers and advisers in the trenches are reporting that the concept of tinkering with match scheduling is trickling down to the small- and midsize markets. But in order to decide how to best proceed when an employer entertains such an idea, advisers need to understand the true motivation behind it.

TALENT RETENTION TOOL

There's the talent retention argument, for instance.

“There's such a hunger for talent that can help accelerate a business and the recruiting is becoming competitive,” said Tom Zgainer, chief executive of America's Best 401(k), a firm that offers fiduciary investment manager services to plans.

“Some companies don't want their employees to take their ideas to a competitor,” he added. “This [change to the match schedule] is an incentive to consider staying or leaving on the employer's terms.”

There's also the “meet the bottom line before making the match” argument.

“On a per-period basis, the employee gets the money and it goes to work for them sooner,” said George Fraser, managing director an! d financial consultant at Retirement Benefits Group, a firm that's affiliated with LPL Financial.

“Some [employers] are considering a year-end match because they aren't sure what the finances will look like; they want to give the most based on their year-end numbers,” he said. “They determine the match based on the company's profitability.”

Finally, there's the record keeping and administration simplification argument.

“Companies that make that decision aren't necessarily doing it for cost cutting but to ease some administrative problems and record keeping issues that plans have,” said Mr. O'Shaughnessy. “I think you'll see more annual funding based on plan designs that incorporate financial wellness — where if you do certain behaviors, you are rewarded with a match and a kicker.”

But many factors go into making discretionary matches, and the changes that could be made to the schedule should be considered alongside the other levers employers can pull. For instance, requiring higher employee contributions before receiving the match or adjusting vesting schedules — while maintaining the match — to ensure the most committed employees are rewarded.

“Even if you had a high-turnover business and your employer wants to retain more money for the participants, you can do that through the vesting schedule structure,” said Francis Gillis, a retirement manager at Dynamic Wealth Advisors.

VESTING SCHEDULES KEY

Vesting schedules are an important factor when it comes to setting matches. Mr. O'Shaughnessy recommends a two- to five-year schedule, considering that younger employees tend to have high turnover and may end up leaving with very little in vested dollars for the early part of their careers. In turn, those who stick around are also rewarded for their loyalty and get to keep their matches when they leave.

“What's the motivation around [the decision]: If it's high turnover and it's a legit decision based on that! , then th! ere could be situations where executing a delayed match is in the best interest of the participant,” said Mr. Gillis. “In that case, evaluate all the elements when you devise a strategy for it. You can't just say you're going to delay the match until the first quarter or year-end.”

Regardless of how plans decide to proceed, advisers should bear in mind the great strides many employers have made over the years to improve outcomes for their workers. Of the 1,014 people who participated in a Bank of America Merrill Lynch survey last March, 84% of the respondents said their employer offers a 401(k) match and 78% contributed enough to qualify for it.

“More companies are being aggressive about their initial default rate, and they're making it higher, and we've seen strong increases in the number of companies using auto-enrollment,” said Kevin Crain, a senior relationship manager at Bank of America Merrill Lynch. “I'm fascinated about companies [changing their schedules] but what's missing here is that there are more people in the system, saving money that they didn't before and they're getting their matches.”