Is YOUR company 401(K) unfair? ‘Free money’ from employer contributions mainly benefits highest earners, landmark research reveals

The 401(K) retirement plan is designed to help employees build savings by setting aside money from their paychecks each month.

In addition, they can receive extra money from their employer through a match.

But new research suggests that these employer contributions mainly benefit the highest earners.

Employers contributed $212 billion to retirement plans — about 58 cents for every dollar participants saved — according to the latest 2021 data.

But about 44 percent of these funds went to the top 20 percent of earners analysis of the Vanguard group.

The lowest earners, meanwhile, received just 6 percent of the ‘free money’ from company matches, it found.

It’s not surprising that a greater share of employer matching dollars goes to those who are paid more, the study said, since matching contributions are typically given as a percentage of salary.

But it suggests that those who earn the most receive a larger share of contributions than their share of income.

The match formulas that companies use vary.

Some companies contribute a fixed amount each year, such as 3 percent of wages, regardless of whether the employee contributes.

A small number of companies contribute to a dollar cap, for example by offering a 10 percent match on 6 percent of pay, with a cap of $6,000.

But the most common match formula, according to Vanguard, is a percentage match.

Normally this will be half of an employee’s contributions, up to a maximum of 6 percent of their salary.

When the employer contribution is based on a percentage of wages, people with higher incomes usually receive more.

But top earners also receive a larger share of 401(K) matching dollars than their share of income, the study found.

On average, those in the highest income bracket of 20 percent received 39 percent of income but 44 percent of 401(K) contributions from their employer.

Those in the bottom 20 percent of income earners, meanwhile, receive a 29 percent smaller share of matching dollars than income, Vanguard found by analyzing more than 1,000 plans between 2013 and 2022.

Dollar matching often exacerbates wage inequality, says Fiona Greig, global head of investor research and policy at Vanguard Group. The Wall Street Journal.

One of the reasons higher earners receive a higher amount of employer contributions is because they are more likely to participate in 401(K) plans and earn enough to get a full matching contribution.

Of the ten most popular matching formulas, all but one 20 percent of earners were disproportionately rewarded with a higher share of matching dollars than revenue.

The formula that is best for a more even distribution of employer contributions is when the funds are capped at a dollar amount, Vanguard found.

Using a dollar cap formula, the top 20 percent of earners received about 33 percent of matching contributions, compared to 35 percent of income.

For example, Costco will match 50 percent of employees’ annual 401(K) savings, up to a maximum of $500.

The most employees can save in a 401(K) for 2024 is $23,000 – according to IRS guidelines – and $69,000 for combined employee and employer contributions.

Those over 50 can also add an additional $7,500 in catch-up contributions.

The Vanguard study exposes the gap underlying retirement in the US.

Research from Fidelity Investments earlier this month found that a strong stock market means there are now more 401(K) millionaires than ever before.

The number of seven-figure 401(K) accounts rose to 485,000 in the first quarter of this year, a 15 percent increase from the previous quarter.

A year ago, according to the investment company, there were still 340,000.

Meanwhile, separate research earlier this year found that a record number of Americans were taking money from their 401(K) plans in 2023 for a financial emergency — as high inflation continues to eat away at savings for many.