If you think about it, a company's 401(k) match acts just like crossfire injection. What's that, you ask? The best way to answer that question is to show you, not tell you.
Remember that Z-28 I alluded to a couple of months back? It's one of those rare Camaros that has this thing called crossfire injection. When I bought one in 1983, I had no idea what the term meant. I'm not sure I know what it means even today. All I know is that it sounds cool. And it works even cooler.
Here's how I would use it. Let's say I was comfortably cruising down some country road counting the passing cows, when I come up on a farm tractor moving at snail-like speed. If you're like me, you know how frustrating this can be. I naturally nudge towards the center line where I discover I've only got a short passing opportunity. If I don't pass this oozing molasses in front of me right away, I'll be stuck behind it for several more agonizingly slow miles.
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This is where crossfire injection comes in handy. I need to pick up speed – and fast. I slip into the passing lane and floor it. Somehow – I know it works this way, I'm just not sure how – my depressing the gas pedal all the way triggers the crossfire injection sequence. Instantly – and unseen under the hood – a valve opens injecting a blast of additional fuel into the combustion chamber. At the same time – and I can see this – the dual flaps pop open, sucking in the fast rushing air into the carburetor to mix with that extra gas. In a moment, the car seems to hesitate before exploding forward under this newfound power.
Within seconds, I'm accelerating down the highway, leaving the sluggish tractor – a fast-shrinking distant object quickly disappearing in my rearview mirror. During those precious few seconds of maximum acceleration, I have to admit I feel like Luke Skywalker racing through space in one of those X-wing fighters. (Hopefully, this admission does not invalidate my lifetime-earned credibility as a Trekker.)
Such is the power and the application of crossfire injection. It's a quick dose of supplementary propellant that allows you to get where you're going a little (or a lot) faster.
The company 401(k) match works in a very similar manner. In giving your 401(k) savings a turbo-boost of free money, it helps your retirement nest grow a little bit faster. (Want to see how fast? Then read "Are 401(k) Plan Sponsors Poised to Cut a Popular Feature?" FiduciaryNews.com, Nov. 5, 2013.)
Now, here's the real scary part of this whole thing.
Two years ago I wrote a piece called The Dark Side of Behavioral Finance. In that article, I mentioned how the lessons of behavioral finance can be used for less than honorable purposes. As it turns out, the purpose doesn't have to be malevolent to produce negative results.
There have now been several studies that have allowed researchers in behavioral finance to conclude the main reason for having a match – to encourage employees to save – is much less effective than merely creating a plan with auto-enrollment and auto-escalation. What's more, there's a growing consensus among service providers who recommend plan designs to shift the typical dollar-for-dollar match on the first 3 percent to a 25 cents on the dollar match on the first 12 percent. The latter strategy is preferred because it encourages employees to save an amount substantial enough to make it really possible for them to achieve their retirement goal. In addition, while both strategies can theoretically cost the company the same, but the latter strategy is more likely to find employees less often receiving the maximum match (thus costing the company less in matching funds).
Employees need all the help they can get to save the amount required to live a comfortable retirement. While auto-enrollment and auto-escalation can definitely help, they shouldn't be used as a reason to shift the traditional dollar-for-dollar match on the front-end of salary deferrals. After all, even if the employee is contributing 12 percent a year, getting the matching money earlier means it can start compounding earlier.
And I needn't remind of the power of compounding.
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Christopher Carosa
Chris Carosa has been writing a weekly article and monthly column for BenefitsPRO online and BenefitsPRO Magazine since 2011 and is a nationally recognized award-winning writer, researcher and speaker. He’s written seven books, including From Cradle to Retire: The Child IRA; Hey! What’s My Number? – How to Increase the Odds You Will Retire in Comfort; A Pizza The Action: Everything I Ever Learned About Business I Learned By Working in a Pizza Stand at the Erie County Fair; and the widely acclaimed 401(k) Fiduciary Solutions. Carosa is also Chief Contributing Editor of the authoritative trade journal FiduciaryNews.com and publisher of the Mendon-Honeoye Falls-Lima Sentinel, a weekly community newspaper he founded in 1989. Currently serving as President of the National Society of Newspaper Columnists and with more than 1,000 articles published in various publications, he appears regularly in the national media. A “parallel” entrepreneur, he actively runs a handful of businesses, including a small boutique investment adviser, providing hands-on experience for his writing. A trained astrophysicist, he also holds an MBA and has been designated a Certified Trust and Financial Advisor. Share your thoughts and story ideas with him through Facebook (https://www.facebook.com/christophercarosa/)and Twitter (https://twitter.com/ChrisCarosa).
