The 401(k) Design Quandary

It's a question that is really in vogue these days: what is the optimal 401(k) design? Should you auto-enroll? Should you match? How big should the match be? How quickly should the match fully accrue?

I read an article yesterday that was written as if it had the authoritative answers. I was amused, to say the least. It said that if you are currently matching 100% on the first 3% of pay deferrals, you should switch to 50% on the first 6% of deferrals. People would still get the same match, but they would defer more in order to get it and the plan sponsor's cost wouldn't change.

Whoa! Hold on.

What are your goals? Can your typical participant afford to defer 6% of pay? If they are currently deferring 3% of pay to get the full match, how much will they have to change their use of their take-home pay in order to be comfortable deferring 6% of pay? Will this affect your ADP and ACP nondiscrimination testing?

Many of the fund houses that are recordkeepers write (and speak) as if they have all the answers. Don't they have an ulterior motive though? They want to get more assets under management. They make more money that way.

Don't get me wrong. This is not intended to say that participants shouldn't be encouraged to save more. They should save as much as possible. But, it's not fair to make blanket statements like the one that was made, and purport that they apply to a general situation.

Plan design studies should not be done based on articles found in internet searches. Just like any other study, they should start with an enunciation of parameters -- goals, constraints, and desired outcomes. And, don't forget risks. No new design should leave a company exposed to risks that are too extreme.

I'll give you a real-life example. I was working with a large company last year that was considering a change to their 401(k) plan. Fortunately, this is an extremely cash-rich company, so if they had decided to make the change they were contemplating, even though the cost increase would have been measured in 10s of millions of dollars, this would not have broken the bank.

Currently, the company offers a match of something like (I don't recall the details exactly) 100% on the first 5% of pay deferred either pre-tax or Roth. They also allow after-tax contributions. They were considering a change to match both (not either, but both) pre-tax (orRoth) and after-tax contributions dollar for dollar on the first 5% of pay. It didn't occur to them that their highly educated workforce would find a way to defer at least 5% of pay pre-tax (or Roth) AND 5% after-tax, to double their match. I'm not sure why.

In any event, do your work properly. Understand your goals, risks, constraints, and desired outcomes. And, just because a design is popular or written up in an article, that doesn't mean it's the right one for you.