One of my favorite pleasures is eating fresh eggs from my own chickens. The yolks are a deeper yellow, and they taste richer than store-bought eggs. However, providing our hens with everything they need to produce these beauties takes patience and a long-term commitment to their care. You can’t just feed them and forget them.
Raising chickens is a lot like saving for retirement
Plan sponsors have the same responsibility to nurture their employees’ retirement accounts. That’s why we encourage plan sponsors who want to boost participant accounts to make ongoing contributions rather than a onetime payment. We share this observation as U.S. corporations are benefiting from the 2017 Tax Cuts and Jobs Act and have additional cash on hand.
There’s recently been a lot of press about employers passing along the money they are saving due to tax reform to feed their employees’ retirement accounts. On the surface this is a good thing. The more employees can save for retirement, the better off they will be. Right? But what if the well-intentioned distribution is done in a way that is unhealthy for the plan?
Here are examples of two methods plan sponsors are using to nurture their employees’ nest eggs. One is healthy and the other is a feed-them-once approach, which may cause long-term harm to a company’s retirement plan.
A one-and-done contribution
First, let’s look at a retail chain. The company has 22,000 eligible employees and a 50% participation rate in its 401(k) plan. Management decides to use company money saved through tax reform to make a onetime retirement account contribution of $100 for each eligible employee.
While employees will receive an unexpected payment, the reality is that to collect it they must participate in their plan. In this case, to distribute management’s gift, the plan has to cover the cost of setting up as many as 11,000 new low-balance accounts. With an annual per-participant recordkeeping fee, many of these accounts will vanish within several years. If not fed regularly, they will never produce anything.
Plus, the chances are high that many of the new accounts will be closed before their balances have a chance to grow. Participants are normally able to take a distribution of their money when they leave the company, and most plans contain a cash-out provision under which the plan automatically distributes accounts with balances of $1,000 or less when the participant leaves. Maintaining these small accounts, or issuing a large number of small benefit checks as part of a cash-out process, can be costly and may hurt the long-term health of the plan.
The second example is a large manufacturer. The company announces that it plans to share the benefits of tax reform with its employees by contributing more to their retirement plans. For each dollar a 401(k) participant contributes, the company pledges to match one dollar up to 5% of an employee’s salary, an increase from the 4% safe harbor recommendation. The company has a 90% plan participation rate among its 2,500 U.S. employees, so up to 2,250 participants may immediately benefit from the increased 401(k) match. Because the gift will be ongoing and the company has a high participation rate, the company is able to meaningfully contribute to long-term value for its employees.
Like properly housing, feeding, and watering chickens so they will lay eggs, your participants’ accounts need regular, quality care to flourish and produce results. If you have the resources to give your 401(k) plan a boost, remember to do so in a way that is most beneficial to the long-term health of the plan.
To learn more, please contact your Vanguard retirement relationship manager.
Notes: All investing is subject to risk, including the possible loss of the money you invest.