Stretch match 401(k) design: motivating participants to save more

Participant 401(k) contribution strategies

Participants who aren’t sure how much they should contribute to their 401(k) often look to their employers for guidance. And this guidance can come in many forms, including your plan design. When asked how they picked their savings rate:

• 32% accepted the default contribution rate² 
• 31% wanted to receive the maximum employer contribution²

That’s why it’s important to make sure your plan is sending the right message about saving. And your employer matching contribution can be a good place to start.

Enhanced 401(k) matching contributions 

Matching contributions are often used to encourage plan participation. But you don’t just want your employees to participate; you want them to choose a contribution rate that will help them reach their retirement goals. That’s where a stretch match may help. Stretching the plan’s matching contribution simply means changing the contribution formula to motivate participants to save more.

Let’s look at a hypothetical example.

• A plan currently matches 100% on the dollar, up to 3% of pay.
• Participants in the plan only defer 3% to get the full match, making their combined employee and employer contribution rate 6%—a level that’s probably not high enough to meet their retirement needs.  
• To encourage higher deferral rates, the plan sponsor considers changing the plan’s match to either:
  • 50% on the dollar, up to 6% of pay, or
  • 25% on the dollar, up to 12% of pay

Both formulas result in a matching contribution of 3% of pay. But setting a higher threshold may prompt participants to increase their contribution rate to 6% or more. That’s because participants often believe the matching contribution percentage is the “right” amount they should be saving. Essentially, what you’re doing is putting the power of behavioral finance to work for your plan.

When setting your threshold, keep in mind safe harbor 401(k) plans can’t have a matching contribution that exceeds 6% of pay.  

Key considerations for your retirement plan design

As with any plan design change, your retirement plan committee should consider the pros and cons of a stretch match before proceeding.   

Potential benefits

• Cost—It’s relatively inexpensive to switch from a traditional match to a stretch match. You may have to pay setup costs and fees to amend your plan document and to prepare and provide a summary of material modification and updated summary plan description. But the overall amount of the match generally stays the same.
• Improved retirement readiness—Participants may increase their contribution rate to receive the full matching contribution, helping them build their retirement savings.

Potential drawbacks

• Effect on lower-paid employees—Lower-paid employees may not be able to contribute at the rate needed to receive the full matching contribution.
• Effect on higher-paid employees—Higher-paid employees may not be able to receive the full matching contribution because of IRS annual contribution and compensation limits. 
• Inertia—There’s no guarantee participants will actually increase their contribution rates.   
• Perception—Participants may have a negative view of the stretch matching contribution formula. So you’ll want to develop a communication strategy if you decide to make the change.

Be sure to include your plan’s financial professional, ERISA attorney, and third-party administrator in your discussions. They can help you evaluate the merits of a stretch matching contribution formula based on your demographics and plan goals. 

Optimize your retirement plan design  

Your plan features, especially the employer matching contribution, send signals to your employees about how much they should be saving for retirement. Make sure your plan design motivates them to save at a level that will help them attain their retirement goals.