The 401(k) is now the most popular type of retirement plan, with many employers offering a company match when employees withdraw money from their accounts. But these matches – often abbreviated as ‘free money’ from your company – could increase pension inequality, new research shows.
About 44% of employer matches are targeted to the top 20% of earners, according to a May study from researchers at Vanguard, Yale University and the Massachusetts Institute of Technology. In contrast, the bottom 20% of workers receive just 6% of matching contributions from their employers, the analysis shows.
There’s a lot of money at stake, as companies provided about $212 billion in matching contributions in 2021, or nearly 60 cents for every dollar saved by employees, the study said. But the bulk of those employer dollars likely go to higher-income workers, even though companies typically use their 401(k) matches as a way to convince all employees, regardless of income, to save for retirement.
“Employer contributions are a ripe target for innovation,” the authors wrote in the report. “They disproportionately benefit people with higher incomes, white workers, people with greater access to liquid wealth and people with wealthier parents.”
The findings come amid growing research into the pitfalls of 401(k)s, which now serve as the primary retirement tool for American workers. About half of all private workers participate in a so-called defined contribution plan, which includes 401(k)s and 403(b)s, compared to about 15% who have access to traditional pensions.
But even as they have displaced traditional pensions, 401(k)s have left the vast majority of American workers behind, said Teresa Ghilarducci, a labor economist and professor at The New School for Social Research in New York. First, many employees don’t have access to them, and second, those who participate in 401(k)s are largely on their own to figure out how to invest and manage them, creating what Ghilarducci to call to action a “weak” DIY system.
After more than four decades of a 401(k) system, nearly three in 10 older workers are nearing retirement without a cent stored. Two-thirds of younger baby boomers I haven’t saved enough for their golden years.
Who saves – and why
To be fair, it’s not entirely surprising that higher-income workers receive a greater share of a company’s matching contributions. For example, consider two employees who put 10% of their wages into their 401(k)s, with the first making $100,000 and the second making $50,000.
In a typical percentage match, where an employer matches 50% of an employee’s contributions to 6% of their pay, the employee earning $100,000 gets a $3,000 match; for the employee making $50,000, the match would be $1,500.
But the analysis found that higher-income workers actually receive a larger share of employer contributions than their share of income. This indicates that workers with the highest incomes enjoy outsized benefits compared to lower-earning colleagues.
The research shows that the top 20% of earners receive an 11% larger share of employer contributions than income, while those in the bottom 20% receive a 29% smaller share of matching dollars than income.
That’s partly because some wealthier workers are more likely to tap into their savings, allowing them to get the most in “free money” from their employers. But these people probably also have other advantages, such as family wealth or a university degreethe study noted.
At the same time, the analysis found that there isn’t much evidence that company matches actually convince employees to save more. A majority of low-income workers do not participate in their 401(k) plans despite their company match, while most high-income workers save above the company match limit even though they may not benefit from additional ‘free money’. ” the research showed.
In other words, 401(k)s provide more support to wealthier people who can afford to save more and max out their company match, while penalizing people who can’t afford to save as much, a previous analysis of the MIT researchers found. The end result is that wealth inequality is likely to persist, they concluded.
There is one type of 401(k) match that offers a fairer distribution of corporate dollars, the recent analysis shows. This type of program is called a dollar cap match and is used in only 4% of 401(k) plans. These programs limit employer contributions to a dollar amount, such as tapping a match of $6,000 per year, regardless of how much an employee earns or contributes.
And employers could add other features to help lower-income workers, such as immediate vesting, automatic enrollment and a higher default savings rate, the researchers noted.
