With the US economy shrinking by an estimated 6.5% in 2020, employers are making difficult decisions about how to cut costs, including laying off or furloughing employees as they evaluate their cash positions during this crisis. Many employers are also considering whether to suspend or reduce contributions to their employee defined contribution plans, as occurred during the recessions of 2001 and 2008. If companies must cut costs to weather this pandemic, we recommend closely considering options to reduce rather than completely suspend contributions in order to maintain the incentive for employees to contribute to their retirement accounts.
COVID-19 is causing nine in 10 Americans financial stress right now, according to a recent survey, and for 23% of them, that worry involves not having enough saved for retirement. These fears are not unfounded: The Employee Benefit Research Institute found that in 2019, 41% of households headed by a person aged 35 to 64 are projected to run out of money during retirement, and retirement withdrawals due to the pandemic are sure to worsen the situation. Black and Latino plan participants are even worse off, with only $25,000 and $39,000 respectively in retirement savings compared with white plan participants who averaged $176,000 in retirement savings.
With about 95% of employers offering a company match or other type of contribution to employee retirement accounts, it has become an expected employee benefit. Employers (retirement plan sponsors) typically choose to match dollar for dollar or 50 cents on the dollar up to a certain maximum percent of the employee’s salary. The most common matching formula is 50% of the first 6% that an employee contributes. Employer matches have been very effective in encouraging employees to save for retirement — 65% of 401(k) plan participants contribute at least enough to qualify for the maximum employer match available from their plans.
Removing an employer match is also, unfortunately, a powerful disincentive. Twenty percent of workers in 401(k) plans that suspended matching contributions in 2008 stopped saving in their 401(k) plans entirely that year, according to EBRI. While suspending employer contributions to retirement plans implies that the suspension is temporary, only 75% of employers that suspended contributions in 2008 had restored them by 2011, and of those that reinstated the match, 23% reinstated with an ample matching formula.
According to the Secure Retirement Institute, 45% of working Baby Boomers have less than $100,000 saved for retirement, and 28% have less than $25,000. Employers and employees pausing contributions further exacerbates an already dire situation. Missing out on an employer contribution can amount to tens of thousands of dollars over the span of a career. Consider an employee making $50K and contributing 6% with 7% return on investments over 20 years: with a 50% employer match, the employee would have accumulated $197,393 in 20 years, vs. only $131,595 without the employer match.
Early surveys indicate that employer match suspensions are at roughly the same level as the Great Recession. In a recent Plan Sponsor Council of America survey, 21.7% of sponsors with 1,000 or more participants in their retirement plans have either suspended or are considering suspending employer matches to retirement plans, in line with the 20% of plan sponsors who suspended or decreased contributions in 2008.
As the ripple effects of the pandemic continue to be felt across the economy and companies must evaluate cost-cutting measures, consider the following best practices to mitigate impact to employees’ retirement readiness:
- Reduce the 401(k) match rather than suspending it. For employers who match dollar for dollar, consider reducing the match to 50% but maintaining the same percent maximum so that employees are incentivized to maintain their contributions.
- Encourage employees to maintain contributions. If employers must suspend their contributions, communications to employees should encourage them to maintain their contributions. Behavioral economics principles such as loss aversion (i.e. for the average employee, pausing contributions now would result in losing out on $50K over the next five years) and social proof (i.e. the majority of employees continue their contributions when their employers suspend matching) can be quite effective in encouraging employees to maintain their contributions.
- Consider low-cost options to support employees in building emergency savings. HR leaders may also examine whether employees took 401(k) loans during the pandemic, which may indicate that they do not have a sufficient emergency savings cushion. In those cases, companies may consider integrating tools and opportunities for their employees to build these liquid savings buffers so they’re less likely to borrow from retirement in the future.
Our research has shown that employer-driven savings interventions, such as split deposits or even incentivizing employees with prize-linked savings programs, can be effective in increasing savings. There are also opportunities for HR leaders to require retirement record keepers to provide emergency savings products that enable liquid savings on the same platform as retirement contributions.
Companies are taking great pains to make these extremely challenging decisions, and have to weigh different options–suspending contributions may mean avoiding layoffs or bankruptcy. For companies facing cost cutting measures right now, keep in mind the impact that pausing contributions has on your employees’ long-term financial security–one in five will likely also stop their contributions, a troubling outcome considering the majority of Americans are woefully ill-prepared for retirement. For companies who have already suspended or reduced contributions, once this pandemic is behind us, we encourage you to return to pre-COVID match formulas.
As companies face difficult financial choices in this economic crisis, it’s important to remember that investing in a financially secure workforce carries many benefits for employers, and can be a competitive advantage to companies as they emerge into a more competitive post-crisis economy.
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