Employers are tweaking and sweetening their 401(k) plans as increasingly the programs become the sole retirement savings vehicle offered by many companies.
Higher company matches and the introduction of automatic enrollment features have been implemented as employers seek to boost retirement savings plans while they phase out their defined benefit pension plans.
While 401(k) plans once were viewed as arrangements to supplement corporate pension plans that provided a specific monthly benefit, unpredictable costs due to fluctuating investments and interest rates prompted employers to move away from those plans to the greater cost certainty of 401(k) and other defined contribution plans.
As recently as 1998, 90% of Fortune 100 companies offered defined benefit plans to new salaried employees, according to Towers Watson & Co. By last year, though, just 30% of Fortune 100 companies still offered them (see chart below).
The Pension Benefit Guaranty Corp.'s insurance program, to which employers with defined benefit plans must pay insurance premiums, covered more than 100,000 such plans in 1985. Today, it's just 22,000 plans.
At the same time, the number of 401(k) plans has skyrocketed leaping from just over 200,000 in 1995 to more than 500,000 in 2011, according to a Labor Department report citing the most recent year definitive statistics are available.
In response, many employers have beefed up their 401(k) plans to compensate in varying degrees for the loss of retirement income employees would have received from their now-frozen or terminated defined benefit plans.
“Employers want to do what they can so that employees are saving enough,” said Rob Austin, director of retirement research in the Charlotte, North Carolina, office of Aon Hewitt.
A major way employers have done that is sweetening the formula used to determine how much they will match employees' 401(k) contributions.
For example, the most popular employer match now — used in 19% of plans — is one in which employers match 100% of employees' salary deferrals, up to the first 6% of pay. By contrast, in 2001, the most common match — used in 21% of plans — was one in which employers matched 50% of salary deferrals, up to the first 6% of pay, according to Aon Hewitt data.
Total contributions that can be made in a year depend on the employer's plan design and the employee's pay (see story at right).
Some employers, especially those that have frozen their defined benefit plans, have done even more. For example, when IBM Corp. froze its defined benefit plans in 2008, it added an automatic employer contribution feature.
Under that enhancement, participants in the cash balance pension plan that IBM froze received a dollar-for-dollar 401(k) plan match on employee contributions, up to the first 6% of pay, and an automatic company contribution equal to 2% of pay.
“When companies freeze their defined benefit plans, some may feel two steps are necessary” for their remaining 401(k) plan, said Jack Abraham, a principal with PricewaterhouseCoopers L.L.P. in Chicago, referring to a sweetened company match and an automatic employer contribution.
Another design change that has taken hold is automatic enrollment — now offered by nearly 60% of employers with 401(k) plans vs. less than 20% in 2005, according to Aon Hewitt.
That approach paid off for Hendrick Automotive Group in Charlotte, North Carolina. Employee participation in the company's 401(k) plan surged to 80% when the company added an automatic enrollment feature in 2011, up from 60% before automatic enrollment was added, said Andrea Darrow, manager of retirement programs.
“We want to take care of our employees and be sure they have a nest egg to fall back on,” Ms. Darrow said.
In fact, “automatic enrollment has been wildly successful” for employers, said Sandra Pappa, a Pittsburgh-based principal in Buck Consultants L.L.C.'s retirement practice.
According to Aon Hewitt research, the average participation rate of employees subject to automatic enrollment is 84.6%, compared with just 62.4% for employees who are not.
But not all design changes have been positively received.
For example, AOL Inc. reversed course earlier this year following a barrage of employee complaints about the internet provider's decision to match employees' 401(k) contributions at the end of the year instead of each pay period.
“We heard you on this topic. And as we discussed the matter over several days, with management and employees, we have decided to change the policy back to a per-pay-period matching contribution,” AOL Chief Executive Tim Armstrong told employees in an email.
The motivation to reduce the frequency of matching contributions is simple: Employers can reduce their costs.
“If you have a lot of turnover, you can save money and reward those who stay with the company,” said Robyn Credico, national director of defined contribution consulting at Towers Watson & Co. in Arlington, Virginia.
Just 8% of employers that match employee contributions do so only once a year, with 86% matching contributions during each pay period, according to Aon Hewitt.