Many employees these days are realizing that the loss of a job benefit they once took for granted—the 401(k) match—is making a bit of a dent in their retirement portfolio. Over time, that dent could become a crater, according to new research from Hewitt Associates. For a younger worker who earns $50,000 and receives a full employer match of 50 cents to the dollar on 6 percent of his or her pay, the match cut means $16,000 less for retirement.
Although controversial, 401(k) match cuts are becoming an increasingly accepted way for companies to slash costs in this recession. And it's not just those in dire straights that are jettisoning their contributions—i.e. the Big Three automakers. Match-cutting is occurring throughout a wide range of industries, and those on board include FedEx, 7-Eleven, Eddie Bauer, Burton Snowboards, and AARP. In all, some 200 companies have announced plans to change or stop making contributions to their employees' 401(k)s or other defined benefit plans since June 2008, according to the Pension Rights Center's running tally.
You might be curious about how much these companies are actually saving by eliminating their 401(k) match. According to Hewitt, companies can save more than $1,500 per employee for a one-year match suspension (assuming the average employer match of 50 cents to the dollar on up to 6 percent of pay.) That adds up to $25 million in savings per year for a typical large company, $10 million for a midsize company, and $2 million for a small company.
Employer matches appear to have a psychological effect on employees. Research shows that when a 401(k) match is offered, more employees participate in a retirement plan. But on the flipside, when companies eliminate the match to their workplace savings plans, almost half see a drop in participation and deferral rates, Fidelity Investments found.
Just about every financial adviser will tell you that halting your own 401(k) contributions is a terrible idea. But here's an idea of the consequences in terms of dollars: If the above employee who earns $50,000 and contributes 6 percent stops adding to his or her 401(k) for just one year, he or she will have $48,000 less for retirement than if the contributions continued. And if that younger worker stops contributing for five years, the loss increases to a whopping $150,000.
So if your employer suspends your 401(k) match, what's the best move? Here are a few ideas:
Save more. With so many competing financial obligations these days, it's tempting to scale back retirement contributions. After all, it's money that you won't see for many years--decades for most investors. "You have to fight yourself right now," says John Carl, president of the Retirement Learning Center. "You've got rising expenses, wages being reduced, employers cutting [401(k)] matches. But this is the time to double-down your contributions if you can possibly afford it. If you can squeak even another $1,000 by, it can make a huge difference in the long term." According to Hewitt's research, the average employee can bridge the gap a 401(k) match suspension creates by upping their contribution by just 3 percentage points a year.
Consider a Roth IRA: This is particularly a good idea for younger investors. Unlike with a plain-vanilla IRA, you contribute to a Roth IRA after you pay taxes on it. Then, once you reach retirement, you won't owe any taxes on withdrawals. Strange as it may sound, think of yourself as a farmer, says Christian Cordoba, wealth advisor and principal at California Retirement Advisers in El Segundo, Calif.: "It's like paying tax on a seed and getting the harvest for free." Before you decide to open a Roth IRA, weigh your current tax rate against what you think your tax rate will be in the future. If you expect that you'll be in a higher tax bracket when you reach retirement, Roth is a good bet. But if you are making a ton of money now—and think your salary will likely be lower in retirement—you might want to delay taxes and stick with a traditional 401(k) or IRA. It's not an either-or decision, though. Consider hedging your bets by contributing to both, says Cordoba. "Say you're putting $5,000 a year into a 401(k)...then it might be prudent to put another $5,000 into a Roth IRA so you have half of your money tax-free, and on the second half, you pay tax."