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Thanks to the COVID-19 crisis, your investment portfolio has most likely taken a hit. But there may be even more retirement related fallout from the coronavirus pandemic: Your employer could freeze their 401(k) matching contributions.
As companies struggle to cut costs and survive, many are laying off workers and slashing extra expenses. Ari Sonneberg, a partner with the Wagner Law Group, notes that 401(k) matching contributions to employee accounts make an attractive target for cost cutting.
“We certainly saw a decrease in employer contributions during the Great Recession and a significant increase thereafter, and we have, in the last few weeks, been getting many calls from plan sponsors looking for advice on how to properly suspend or reduce employer contributions,” Sonneberg said. “During recessions, employers look to reduce expenses — reducing their retirement plan obligations is no exception.”
If your company is planning on suspending its 401(k) contributions, take these steps to protect your retirement fund.
How Employer 401(k) Matching Contributions Work
For employees, 401(k) matching contributions provide a powerful boost to retirement savings; for companies, they are a useful tool for recruiting and retaining employees. In recent years, a 401(k) match has become an increasingly common part of benefit packages. According to Vanguard, 95% of the employers who use it to administer their 401(k)s matched retirement plan contributions by their workers.
With employer-sponsored defined contribution retirement plans like 401(k) accounts, employees contribute from their salary, usually on a pre-income tax basis. (According to Vanguard, more than 70% of plans also offer the option of making after-tax Roth contributions.)
Employer matches vary widely in their generosity, but the most common one among Vanguard plans is a 50% match on the first 6% a worker saves. In other words, if an employee saves 6%, the company kicks in 3%. Some companies offer tiered matches — a common tiered formula matches the first 3% the employee saves dollar for dollar, and then the next 2% at a 50% rate. In such a plan, if you save 5% of your salary, your employer will kick in 4%.
Let’s say your employer is more generous than average and offers a dollar-for-dollar match on your retirement contributions up to 5% of your salary. If you earn $40,000 per year, your employer will match up to $2,000 of your annual contributions.
Whatever the formula, employer 401(k) matching contributions are essentially “free money,” making them a highly valuable benefit for employees. Taking advantage of an employer’s match could help you dramatically increase your retirement savings.
Employers Are Suspending 401(k) Matching Contributions — Again
Suspending employer contributions to retirement accounts isn’t a new tactic. According to a survey by Willis Towers Watson, almost 20% of companies with at least 1,000 employees suspended or decreased their retirement plan contributions during the 2008 recession.
Already, several large employers, including Haverty’s and Amtrak, have announced that they are freezing their 401(k) contributions in response to financial stress stemming from the coronavirus outbreak, including While 401(k) matching contributions are a key part of a compensation package, your employer can often stop making contributions at will—it’s perfectly legal.
“Many typical 401(k) plans contain provisions for an employer discretionary contribution to the extent that if an employer has been making these types of discretionary contributions, no notice to participants is required by the plan sponsor to stop making them or to reduce them,” said Sonneberg.
However, some employers will need to take certain steps before they can suspend contributions, such as giving employees notice.
If the employer offers a Safe Harbor 401(k), the company is subject to certain notice requirements. If the employer intends to make midyear changes to the 401(k), such as stopping employer contributions, it must inform employees of the intended change and its effective date at least 30 days in advance. Non-Safe Harbor 401(k)s generally do not require companies to provide advance notice when freezing matching contributions.
The suspension of 401(k) contributions can be a significant blow to employees. However, Amber Clayton, the knowledge center director with the Society of Human Resources Management, said it’s something companies are only doing as a matter of survival and not as a long-term solution.
“[...] But employers who do this would likely do so in the short-term as 401(k) plans are important for employees as well as potential job candidates,” Clayton said. “A longer suspension could result in turnover or recruitment challenges.”
What To Do If Your Employer Suspends 401(k) Matching Contributions
Finding out that your employer has suspended their 401(k) match can be disheartening. But before making any drastic changes to your own 401(k) contributions, follow these tips to minimize the impact of your employer’s decision.
1. Think carefully before withdrawing money from your 401(k) account
With the economy and stock markets in turmoil, you may have considered withdrawing funds from your 401(k) to have cash on hand to cope with financial hardship.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act made it easier than ever to tap into your retirement fund. Previously, withdrawing money from your retirement accounts before you reached retirement age resulted in a 10% early withdrawal penalty, except in certain circumstances. The CARES Act waives the penalty for certain people experiencing financial adversity due to COVID-19. (It also gives you up to three years to repay the money to a retirement account and avoid the income taxes that would ordinarily be due on any distribution of pre-tax retirement funds.)
However, dipping into your retirement fund can be a costly mistake. Brandon Renfro, a Certified Financial Planner and assistant professor of finance at East Texas Baptist University, recommended that you leave your money where it is.
“Don't give up and withdraw the money that is already in your 401(k),” he said. “That money is still working for you.”
If you take distributions from your 401(k), you’ll lose out on potential growth and market gains when the market recovers. That decision could hurt you later on as you get older.
Need cash now? Consider these options instead.
2. Time to review your investment strategy
While you shouldn’t take out money from your 401(k) if you can avoid it, this would be a good time to revisit your investment allocations.
“The market volatility will have likely thrown your portfolio out of balance,” Renfro said. “Readjust to get your investment mix back aligned to fit your plan.”
If you don’t have a set investment strategy—or don’t feel comfortable with the current plan you have—it may be worth working with an investment professional or a robo-advisor to choose a new investment mix based on your goals and risk tolerance.
“It's also a good time to think about how you reacted to the market drop,” Renfro said. “If you panicked or didn't stay the course, then maybe it's time to re-evaluate how you invest. It may be that you need a new plan going forward.”
3. Maintain your retirement contributions — or increase them
Even though your employer may have suspended matching contributions, you can keep contributing to your 401(k) on your own. If you can afford to, contribute more in order to make up for the temporary loss of your employer’s 401(k) match. For 2020, workers can make up to $19,500 in pre-tax or Roth contributions, plus an extra $6,500 if they will be 50 or older by the end of the year.
Alternatively, you might consider redirecting a portion of your retirement contributions to a Roth Individual Retirement Account (IRA). Contributions to a Roth IRA are made with funds on which you’ve already paid income tax, like the Roth 401(k) contributions mentioned above, and in many cases offer more flexibility when it comes to investment choices and withdrawals.
“If you are able to, the biggest thing you can do is make up for the reduced employer contribution by saving more yourself,” said Renfro. “Of course, that may not be so easy. It may take some budget trimming, but if you can manage it, you'll be much better off in the long run.”
By staying the course, either in your 401(k) or a Roth IRA, you can continue to grow your nest egg and take advantage of a stock market recovery, when it inevitably arrives. If you can afford to increase your contributions, it will also keep your retirement plans on track.
Suspensions won’t last forever
The COVID-19 financial crisis is impacting companies and employees in many different ways; suspending employer retirement plan contributions is just the latest step as companies attempt to stave off employee furloughs and layoffs.
Because of the sudden and unexpected arrival of COVID-19, many employers have been forced to take drastic steps to stay afloat. While finding out that your employer is suspending its contributions can be frustrating, you should know that it’s likely a short-term phase that will last only until the economy recovers.
“Retirement plan employer contributions are a tool used for retaining existing employee talent and attracting new talent, so as soon as employers are in a position to revisit their contribution suspensions or reductions, history tells us that they will,” said Sonneberg.
