The retirement industry loves plan design.
We debate whether an employer should match 100% of the first 3%, 50% of the first 6%, or stretch the match over a higher employee contribution. We add automatic enrollment, automatic increases, financial education, calculators, contests, meetings, videos, and colorful websites.
Some of these features help.
But they cannot solve the most basic problem: An employee cannot save money that is needed to pay this month’s bills. I see this over and over again as I travel the US meeting with my client 401k employees.
What Vanguard Found
A recent Vanguard study examined the effectiveness of common 401(k) match formulas. The findings should give employers and retirement-plan advisers pause.
Only 22% of employees earning $30,000 or less contributed enough to receive their full employer match. Among employees earning between $30,000 and $60,000, the figure was 52%. I was talking with a working mom at Progressive. At 56, she is earning $53,000. She is wracking her brain to come up with other sources of income.
Participation improved considerably as income increased.
Vanguard also found that almost 60% of employer matching dollars went to employees who were already contributing above the match limit. These employees probably would have saved much of that money regardless of the match.
Meanwhile, many lower-income employees contributed nothing and therefore received nothing from their employers.
This is not evidence that lower-paid employees do not understand the value of an employer match. It is evidence that the ability to save is not distributed evenly. As some of you know, early on in my career, I was working part-time while pursuing my MBA full-time. My blushing bride, having newly arrived in the United States, was not working yet. We needed every dime we had.
The Match May Be Generous but Still Unreachable
Consider an employee earning $40,000.
A 4% contribution equals $1,600 a year, or about $133 a month. To someone with adequate income, that may appear manageable—particularly when an employer is offering additional money.
But the decision looks different when that $133 is needed for rent, groceries, transportation, health care, childcare, or an overdue utility bill.
The employer may describe the match as “free money.” To the employee, accessing it requires surrendering money that is not free at all.
That distinction is too often missing from retirement-plan discussions.
We tell employees to start small. We encourage them to increase their contribution by 1%. We explain compound growth and the cost of waiting. Sometimes we imply that better budgeting will solve the problem.
Education can help someone decide what to do with available income. It cannot create income that does not exist. I sometimes frame the conversation asking what $40,000 means in the community I am presenting in. In many cases, $40,000 is not enough to get by, and the audience usually says they have a second job or quite a few roommates.
What Does a Living Wage Actually Cover?
The MIT Living Wage Calculator estimates the local earnings required to pay for a household’s minimum basic needs. Its calculation includes food, housing, transportation, health care, childcare, internet access, other necessities, and taxes.
It does not include retirement savings. It also excludes emergency savings, leisure, vacations, restaurant meals, and many expenses beyond basic needs.
That means an employee earning exactly the calculated living wage does not necessarily have room in the household budget for a 401(k) contribution. The wage is designed to cover the present—not finance the future.
For an employee earning less than that amount, the shortfall is even more pronounced.
In that situation, a more attractive match formula may change the incentive, but it does not change the employee’s financial capacity to respond.
Vanguard’s Proposal Is an Improvement
Vanguard recommends replacing common match formulas with a combination of:
A 2% employer contribution for every eligible employee, regardless of whether the employee contributes.
A 25% match on employee contributions up to 8% of pay.
Automatic enrollment.
Immediate ownership of employer contributions.
This is a meaningful improvement.
An employee who cannot afford to contribute would still receive 2% of pay toward retirement. Vanguard also found that these unconditional employer contributions did not cause employees to reduce their own saving. In the plans Vanguard studied, employee contributions remained steady or increased slightly.
The proposal also directs fewer employer dollars toward employees who are already saving beyond the match limit and extends some retirement benefits to those currently receiving nothing.
But it does not eliminate the underlying problem. To receive the remaining 2% employer contribution under Vanguard’s proposed formula, an employee must contribute 8% of pay.
For someone living paycheck to paycheck, that remains a substantial hurdle.
Begin With the Employer’s Objective
Before selecting a match formula, an employer should decide what the retirement contribution is intended to accomplish.
Is the goal to encourage employees who already have disposable income to save more?
Is it to provide every employee with some retirement benefit?
Is it to recruit and retain employees?
Or is it to help the entire workforce move toward a more secure retirement?
Those objectives are not identical.
If the goal is broad retirement security, a match-only formula has an unavoidable weakness: It provides the greatest benefit to employees who can afford to contribute and may provide nothing to those facing the greatest financial strain.
A contribution made for every eligible employee addresses that weakness more directly than another campaign encouraging people to “take advantage of the match.”
Look Beyond the Plan Document
Employers generally review compensation, health insurance, paid leave, and retirement benefits separately. Employees experience them as one financial reality.
A more generous health plan may leave an employee with more money available to save. Predictable scheduling may reduce financial instability. A living wage may make participation possible. An employer retirement contribution may begin building savings for someone who cannot yet contribute personally.
These decisions are connected, whether or not they appear in the same benefits report.
That is why retirement-plan discussions should include more than participation rates, average contribution rates, and the percentage of employees receiving the full match.
Employers should also ask:
How many employees earn enough to meet their basic household expenses and still contribute to the plan?
Without that question, we risk treating the symptom while avoiding the cause. And I just had this conversation last Tuesday in Southern California. If the other benefits are needed more urgently than a retirement plan, then perhaps it is time to look at shutting the retirement plan down. What do your employees need?
The Parting Glass
A better 401(k) match formula can distribute employer contributions more fairly. Automatic enrollment can make saving easier. Education can help employees make informed decisions.
None of these can manufacture disposable income.
We should continue improving retirement plans. Vanguard’s proposal deserves serious consideration, particularly its contribution for every eligible employee.
But we should stop pretending that every failure to contribute is a failure of knowledge, discipline, or motivation.
Sometimes the employee understands the match perfectly.
The paycheck simply does not stretch far enough to reach it.