401(k) Design: How Do Matching Contributions Affect Participant Behavior?

You can find survey upon survey, and study upon study. Just how does 401(k) plan design affect participant behavior? Intuition says that when you increase the employer matching contributions, participants will defer more. However, a study by Choi et al suggests the contrary to be true (you can see my comments on that study here: http://johnhlowell.blogspot.com/2010/11/does-401k-match-not-promote-savings.html ). Conversely, a large number of studies suggest that as employers increase their matching contributions, employees increase their 401(k) plan deferrals.

But, how does specific design affect participant behaviors? Which way of offering a 2% of pay match gets participants to defer the most? The Principal Financial Corporation did an interesting analysis of this question. They considered these three matching schemes:

• 100% on the first 2% of pay deferred
• 50% on the first 4% of pay deferred
• 25% on the first 8% of pay deferred

In the first scenario, they found that the average participant deferral was 5.3% of pay. In the second scenario, it was 5.6% of pay, and in the third scenario, it was 7.0% of pay. And, for the three scenarios, total additions to participant accounts were 7.3%, 7.6%, and 8.8% of pay respectively. Interestingly, the third scenario costs the employers the least, but prepares participants best for retirement.

Excellent food for thought. You can read Principal's summary here: http://www.principal.com/about/news/2010/ris-match-stats113010.htm