Thursday, July 05, 2007

401K Matching: the Pitfalls

This is the fourth post in my 401k week series. Previous posts have dealt with the many features in our new 401K plan; with the concept of a ROTH 401K; and with the reasons we decided to dump ING as our 401k plan provider.

If you are lucky enough to be in a company that matches your 401K contributions, not taking advantage of this free money is practically a crime. Nevertheless, even if you are taking full advantage of the matching, there are a couple of things that you should watch out for:

1. What is being matched? My company matches 50% of the first 6% of pay contributed to our 401K plan. However, matching is only awarded for contributions out of base pay. Bonuses are not matched. Be aware which contributions entitle you to the company match, and make sure you contribute enough to get every free dollar you can.

2. How is matching calculated? My company matches employee contributions on a per-pay-period basis. You only receive matching funds for the first 6% of contribution out of each pay check. This means that if your 401k contribution rate changes throughout the year you may not get the full amount of the match.

For example, an employee who makes $100K per year and wants to max out his contribution at $15,500. If he contributes an even 15.5% of salary per pay period, by the end of the year he will receive company matching of $3,000 (50% match up to the first 6% of salary). However, if the employee wants to max out his contributions by June 30, he will only be getting a total match of $1,500 that year - because contributions in excess of 6% per pay period are not matched. If you are not aware of this and your contribution rate varies over time, you may be leaving money on the table.

This matters especially if you are a new employee joining the company in the middle of the year, or if you are about to quit your job. In fact, this is exactly why this policy is in place. The company wants to ensure that employees are not able to max out their contributions early, get the full match for the year and then quit.

3. Be Aware of Your Vesting Date - most companies that match employee contributions require that the employee work for the company for a certain period of time before the employer match is completely vested. My company has a four year vesting schedule, where 25% of the matched funds vest each year. My wife's vesting schedule is three months - her company matching funds vest at the end of each fiscal quarter.

It is important to know your company's vesting schedule for two reasons. First, if you are thinking about switching jobs, it may be a good idea to time your departure such that it happens after your closest vesting milestone. For example, I vest in 25% of my company match every May. If I wanted to quit my job and were to get a good offer with another company in April, I would try to postpone my departure date by a month to vest in more of my matching funds. Of course, there is no point in missing out on a great career opportunity for a couple of thousand dollars, so use common sense.

It is also worthwhile to check up on your vesting, even if you have no plans to go anywhere. One of my colleagues recently noted that his account did not show a vested match balance, even though he was with the company for two years. When he reported the error, it was corrected within days.

4. Matching in Company Stock - you would expect that after the Enron scandal people would realize that investing large amounts of money in your own company stock was a bad idea. You would also hope that companies would realize that it is not fair to match employee contributions using company stock. No such luck. My wife's company matches her contributions in company stock. On the plus side, since her match vests every quarter, we sell the stock and invest the proceeds in a more diversified investment option. For more about why I think it is a bad idea to invest in your own company stock, check out this post.

8 comments:

Traciatim said...

Hmmm, maybe I don't like your company plan as much as I thought. Ours is a 6% salary match per pay, 100% matched by the company and instantly vested. So theoretically I could put the money in to it and each quarter withdraw it all and put it in to my own self directed RRSP.

4 Years seems like an incredibly long time, is that normal south of the border?

Shadox said...

It really changes. My previous company had no vesting schedule at all. Everything vested automatically.

Regarding the match, I am actually discussing this with our VP of Finance right now. My hope is that starting Jan 2008, the match will increase to 100% of the first 6% or at least 100% of the first 3% & 50% of the next 3%.

Anonymous said...

Hi there,

My friend found a problem with the 401k matching at the company he works for, and I'm looking around to see if anybody else has had the same problem, so I stumbled on your site here.

At the company he works for, HR claims the same matching you described. Up to 6% of eligible salary, matching 50%. They process the company matching on a per pay period basis, so if you don't contribute for a pay period, you miss out on the company match. Sounds ridiculous that you have to play w/contribution %s if you want to max out and get full company match.

The problem is in the way the company match is described in the company literature:
"The Company adds a matching contribution equal to 50% of the first six percent of eligible pay which you contribute to the plan."
According to that definition, it doesn't matter when he contributes his 6%, as long as he contribute 6% for the year, the company should be contributing 3%. With the per-pay-period matching, that isn't always the case.

HR didn't see things his way so he did some research.
Came across the following link:
http://www.irs.gov/pub/irs-tege/401k_mistakes.pdf
(Look at issue #4)
Now he has some ammo to get some attention.

Sorry for the long post...
I guess what I'm trying to say is, it depends on the way your company matching is described in the company literature. If it says it will perform matching on a per-pay-period basis, then you don't have a problem. But if it is like my friend's, it sounds like you may have some issues to address.

The latest I heard, they were going to look into it with the legal dept.
I think they owe people some money. The ugly thing is that this has been going on for as long as the 401k matching program has been in place, probably more than 10 years. ouch!

Hope this helps somebody.
Cheers!
Goody_Two_Shoes

Anonymous said...

I have an offer from a company and here is what they are doing for 401K.

100% for the first 3% of employees contribution and at 50% for the next.

Does it looks like a good 401K matching?

Any feedback would be greatly appreciated.

Shadox said...

Sorry for the late response. This sounds very decent. Many companies only match 50% of the first 6% - if at all (my current employer doesn't match at all) - your offer is higher than that, although it is certainly not one of the "awesome" ones.

Anonymous said...

if a company terminates an employee can they "take back" unvested 401k mathing funds

Shadox said...

They can and they do.

Anonymous said...

I have a company that offers a match of 100% for the first 3% deferred and 50% on the next 2% deferred for a maximum company contribution of 4% per paycheck if you contribute 5% or more.

Bonus: They offer a true up match at the end of the year. They take your average deferral percentage through the year, divide that by your eligible salary for the year. Then take that and determine how much you should have received for match, and then contribute any difference.
Sounds great, right?

However, let's say you contribute the max of $16,500 for the year. Depending on how much you make you could get a completely difference amount of match than someone who makes something different than you.

Get this: Someone who makes $245,000 will get $9,800 in match, which is 4% of $245k. While someone who makes $57,400 will only get about $2,296.

Seems to me like they are screwing over the little guy cause they are basing the true-up on salary and not on actual deferrals.

I did check the plan document and they are doing it as it's stated in there.