Lump-Sum Year End 401(k) Matching

You may have heard, or read, something about the AOL brouhaha recently. If you haven’t, here is a quick summary for you.

Employer Matching ContributionsIn a CNBC appearance recently, Chief Executive Officer (CEO) Tim Armstrong announced that effective this year, 2014, AOL would make a change in the way it distributes 401(k) matching contributions to employees. Instead of providing matching contributions with every paycheck, which is traditionally the norm, AOL would match employee 401(k) contributions at the end of the year. That means employees who leave the company before Dec. 31 would not get the year’s company match at all.

The rationale behind the move? The Affordable Care Act (ACA), derisively known as Obamacare, had resulted in an additional $7.1 million expense for the company. Many people found the timing of the announcement odd as AOL had recently released better-than expected earnings and revenues.

The howls of protest started almost immediately. Primarily because Mr. Cook cited two distressed pregnancies (bad form!) costing $1 million each – touching on the health care expense – but also because people understand that the move essentially saves money for the company…at the expense of rank and file employees. By Saturday, the CEO had apologized and reversed course. AOL decided to maintain their policy of matching contributions with every paycheck.

And that second part is what I would like to discuss. Not the political aspects of the story. As a business major – MBA with a specialization in management – I understand, and believe I could make a business case (without referencing distressed pregnancies), why switching to lump-sum year end 401(k) matching is good for the company.

However, this is personal finance blog – with a focus on retirement planning – and my goal is to educate and inform readers, the individual, about all of the things that can, and will likely, impact managing their portfolio and achieve financial freedom en-route to retirement.

One important thing to remember is that even though AOL reversed itself, the practice is becoming more widespread. With that said, let’s imagine a fictional employee (Bob) at a company that uses lump-sum year end 401(k) matching and see how such a policy would impact his retirement portfolio.

First, let’s get some numbers together. Let’s assume Bob starts the year with $75,000 in his 401(k) account. He contributes $600 twice a month ($1,200) and his company matches $100 every paycheck ($200/month). And let’s assume the market gains an average of 1.5% each month. Plug all the numbers into our magic compound interest calculator…

Paycheck Matching

 Monthly Matching 

Year End Matching

 Lump-Sum Year End Matching

While the $247.36 difference may not seem significant, at least to some, that is $247.36 that will never be working for Bob. Not during the current year, the following year, the year after that….

Moreover, the money “lost” gets more significant every year, which means every year the amount of money not working for Bob increases. If you would like a refresher on the significant power of compound interest, you can look here and here.

What say you SavvyReader? What do you think of lump-sum year end 401(k) matching?

Blogger-in-Chief here at RetirementSavvy and author of Sin City Greed, Cream City Hustle and RENDEZVOUS WITH RETIREMENT: A Guide to Getting Fiscally Fit.

10 Comments

  1. Way cool! Some extremely valid points! I appreciate you writing this post and the rest of the site is extremely good.

  2. Solid explanation. However I think the issue is pointless except for talking points on MSNBC about evil corporations.

    As matching money, it’s the company’s money, not the employee’s, at least until the end of the CY. The company can choose to deposit at the year end, or by month, or any other way allowable by the plan agreement and ERISA. After all, a 401(k) is a form of profit-sharing, not charity.

    On the other hand, as an employee, I’d like to get my entire annual paycheck on Jan 1st. Think about how much money workers are losing by having that money spread out over the whole year!

    • Agreed. Ultimately it is the employer’s decision as to when to make the match. And clearly, a number of companies have decided to match at the end of the calendar year (CY). As you point out with regards to paychecks, it is better to receive money – whether it be a salary, matching contributions, etc. – sooner rather than later. The sooner it is in your grubby little hands, the sooner it can work for you. Time and compound interest are wonderful things. Thanks for stopping by and adding to the conversation, Rob.

  3. Great post!
    This is one of the best explanations and examples of investments I have seen on blogs.
    Keep up the great work. This is great!

    • Thanks for the kind words, David and thanks for stopping by. I hope you will take the time to do so more often.

  4. Hi James:

    I backed into an average annual impact number of $88/employee using annual rate of return of 8%. (I backed into the number by looking at AOL’s annual contribution of $11 MM for about 4,500 plan participants)

    I think the annual return of 18% is overly optimistic and overstates the impact. Also, not all years are up years. Employees could be better off with a year-end contribution in down years.

    I know that small $$$ have big impact with 20+ year compounding, but I don’t think it is $247.

    @tomob

    • Tom, Thanks for stopping by and taking the time to comment. With regards to the specific numbers (e.g. matching amount, rate of return, etc.) they are all made up, as I indicated in the post. The key is that they are the same, the only difference being when the matching amount is made. It is an apple-to-apple comparison. Is 18% overly optimistic for every year? Sure. Is 18% significantly less than what the S&P returned last year? Absolutely. By all means, plug in different numbers. However, it will not change the bottom line, all else being equal, individual investors are better served by making (and receiving matching) contributions on a regular interval, particularly over a long time horizon.

      Regarding the idea that investors would be better served in years where the market is down, well sure they would be. But then that would suggest that you believe the market is going to be down more years than up over say a 10, 15, 20 year period. If that is the case, if that is what someone believes, the equity markets are probably not the best place for them to try to build a retirement portfolio.

      You might want to reconsider that last statement, “I know that small $$$ have big impact with 20+ year compounding, but I don’t think it is $247.” The numbers do not lie. Please feel free to check the math. I like to use the compound interest calculator at MoneyChimp.

      Using AOL’s number of $88 per employee, wouldn’t you rather have that $88 working for you? Just as an example of the power of compound interest, I plugged in the following numbers:

      Principal = $75,000 — Annual Addition = $100 — Years to Grow = 20 — Interest Rate = 8% (AOL’s number) The result? $354,514.08.

      What if you increased the Annual Addition by $88 per year?

      Principal = $75,000 — Annual Addition = $188 — Years to Grow = 20 — Interest Rate = 8% (AOL’s number) The result? $358,863.30. A difference of $4,349.22.

      Over a 20+ year period, the difference would be significantly more dramatic. By all means, please check out the Compound Interest posts I referenced in the post.

      It is not my desire to beat up AOL or any other company that decides to use lump-sum year end 401(k) matching. My primary objective on this blog is to apprise readers of factors that can/will impact their retirement portfolio. However, make no mistake, they are doing it to save money. Mr. Armstrong from AOL said as much. How are they saving money? By holding onto the capital longer and putting it to use earning returns. The same returns employees could be earning if the money was working for them throughout the year.

      Again, thanks for stopping by. Great to get new perspectives.

  5. If I were an AOL employee & AOL had not reversed their decision, continuing to only contribute at year’s end, I’d start looking for a position with another company.
    I fully understand that companies need to do what is needed to survive. If AOL were to fail, THOUSANDS would be unemployed.
    But, companies need to understand that their employees are hugely important to the success of the company. If you reduce their potential for future financial security they will seek other options.
    I do not support year-end contributions but, at the same time I recognize a CEO’s right to look out for the good of the company in order to assure continued employment of current employees.

    • No doubt that balancing the needs of the business, shareholders, and employees can be a tricky proposition.

      I believe the main thing employees – as individual investors – need to be aware of is that there is likely to be a continued erosion of benefits. This is just one way in which it will take form. Savvy individuals will understand that they need to stay vigilant with regards to an ever changing economic environment and manage/adjust their retirement portfolio accordingly.

      • I agree that this is a domino to be followed by many others. As my wife and I have spoken of many times, “we need to be financially smart in order to insulate ourselves from the actions of those outside our control”.

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