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Substituting Profit-Sharing for a 401(k) Match

401(k) plan sponsors are eyeing profit-sharing to match contributions based on company results.

During the depths of the downturn, 8 percent of plan sponsors eliminated or reduced 401(k) matching contributions. Now, as the economy picks up, two thirds of those expect to restore the matches in some form by April 2011, according to a survey of 200 large companies conducted last October by Watson Wyatt Worldwide, which has since merged with Towers Perrin to form Towers Watson.

The question is: In what form? For almost as long as 401(k) plans have existed, the typical match has been a fixed percentage of an employee’s input — generally, 50 percent of the employee contribution, with a cap of 3 percent of salary. Now, however, consultants, money managers and other specialists say that a significant number of the match droppers want to shift to a “discretionary” match that will vary according to their profits. That was the explicit intention of 17 percent of the companies surveyed by Watson Wyatt.

Robert McAree, a senior vice president and retirement practice leader at New York–based Sibson Consulting, says that as many as 25 percent of Sibson’s clients that dropped or reduced their match are considering this change. “It will become more prevalent, so that organizations can adjust their contributions depending on business conditions,” he explains.

Other sponsors are eyeing different ways to tweak — and usually shrink — their matches, such as reducing the fixed percentage or paying the match quarterly or annually. “They are taking the opportunity to optimize the benefits end,” says Michael Doshier, vice president of the workplace investing group at Fidelity Investments.

One solution seems to be particularly popular with Fidelity’s clients: profit-sharing. And they appear to be far from alone. McAree and Robyn Credico, a senior consultant at Towers Watson, say that companies of all sorts are considering profit-sharing. Nonetheless, David Wray, president of the Profit Sharing/401k Council of America in Chicago, points out that it’s mainly larger companies, as many smaller firms already base their donations on profits.

Somewhat surprisingly, the chief incentive for companies is not to reduce costs. Wray notes that the typical profit-sharing 401(k) contribution is historically about the same size as the typical match, though “companies probably save money when they need to” — that is, when profits are down. Another potential savings exists for companies with high turnover: Because the profit-based contribution is tallied at year-end, “you don’t have to give it to people who terminate during the year,” explains Credico.

On the other hand, a profit-sharing match could cost more over the long run, depending on how it’s implemented. McAree says that some Sibson clients might maintain a traditional match at a reduced level — maybe half to 75 percent of their old amount — and then augment it with a profit-based contribution in good years. Thus the profit-sharing component could bring the total match to less than, equal to or more than the usual 3 percent of salary.

Rather, Credico says, the real motivation for making a change is that “companies want the flexibility.” A sponsor is not legally required to make a traditional match — and, in fact, about 5 percent suspended it during the last big downturn, in 2001–2002, according to Lincolnshire, Illinois–based consulting firm Hewitt Associates.

Yet employees have come to expect the “free money” year in and year out. With profit-sharing, by contrast, “employees know it’s not guaranteed, because it’s more tied to the company’s results,” says Pamela Hess, Hewitt’s director of retirement research. Thus “profit-sharing might be a little easier to turn on and off.”

The Profit Sharing/401k Council’s Wray adds: “There’s clearly the thought by some companies that it’s better to connect the match up front to the company results, rather than have to go back to participants and tell them they’re not going to get the match they expected. You don’t want participants to believe one thing and experience something else.”

What about morale issues? Towers Watson’s Credico proposes one response to employees unhappy with their share of the profits in a bad year: “We are committed to helping you save, but clearly, we have to stay in business. Wouldn’t you rather have a job with benefits than no job?”

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