Better Plans for the Better-Paid: Determinants and Effects of 401(K) Plan Design
56 Pages Posted: 13 Jul 2005
Date Written: 2005
This paper seeks to understand why plan sponsors design their 401(k) plans the way they do. Drawing on a rich dataset of several hundred 401(k) plans, we find support for the argument that these plans are principally a form of tax-motivated compensation. In other words, to appeal to better-paid workers, employers provide more generous matching contributions and non-cash plan design features. At the same time, complex federal tax rules restrict pay discrimination in favor of the highly-paid, so these plans must also incorporate monetary and non-monetary incentives to induce a minimum level of participation by lower-paid workers. We show that, since all employees do not avail themselves of these saving incentives, the median employer promises a match equivalent to 3% of pay yet spends only about 2%. Also, generous match rates enhance participation by the lower-paid, but do not do much to increase plan-wide saving rates. Overall, employer 401(k) matching contributions are an imperfect vehicle for advancing broad-based retirement security objectives, and they have an uneven impact across firms.
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