The recent global pandemic has caused many different types of economic fallout. Many companies have suspended or lowered the matching of their employee’s 401(k) contributions. The Plan Sponsor Council of America conducted a survey. It discovered over 20 percent of large companies and organizations are currently suspending their matching contributions. A report from the Center for Retirement Research showed companies that have suspended 401(k) matches for its employees in past and current economic crises.
While retirement plans for employees are a requirement for companies of a certain size or larger in some states, it is not a nationwide requirement, at the current time. For employers that do sponsor 401(k) plans, the benefit is offered primarily as an inducement to attract qualified and desired employees. An employer match for contributions made to a 401(k) plan is not required by law, and is generally a percentage of the employee salary, up to a maximum percentage, what the employee contributes to the account themself.
Why would an employee want to either continue or discontinue contributing to the 401(k) plan sponsored by their employer?
Contributions to a 401(k) are not tax-free — they are tax-deferred. The contribution is not taxed when it is made, but withdrawals from the account will be required when the account holder achieves a certain age (currently 72), at which point prevailing tax rates will apply.
Current marginal tax rates, as established in the 2017 Tax Cuts and Jobs Act, are at historically low levels. Under the Act, tax rates will return to prior levels at the end of the 2025 tax year. However, political changes can always alter these provisions.
Most financial advisers will recommend that an employee contribute to a 401(k) and take the maximum employer contribution — after all, it is “free money” that will build the cash value in the account.
Financial planners, acting as fiduciaries in clients’ best interest, will typically explain that continuing to contribute to a 401(k), even without the employer match, is a practice that can serve an employee well, by keeping their retirement plan in place. Employees have already done all the important budgeting decisions to regularly contribute to their 401(k) plan.
They will also note, that without the employer match to magnify the accumulation of cash value, there are other options for the investment of the employee contribution that can also be part of retirement income, but without taxes being due at retirement age, when marginal rates may very well be higher. Some such opportunities may also provide protection from market losses for the investments.
A 401(k) is one of multiple tools to save for the long term, and retirement. But it is also important a person does what is necessary to not neglect short term needs. If someone does not have an emergency fund to cover their expenses (salary x 6 months), they may need to redirect some of their 401(k) savings to create such a financial cushion. Should someone not have any emergency savings, they are in a position where they may have to take out a loan or make an early withdrawal from their 401(k) plan, which not only carries a tax requirement but also a penalty if made before age 59½.
If someone is significantly financially impacted by the recent pandemic, they need to consider how much they need to use to pay their regular expenses. This may be a situation where a worker suspending their 401(k) contribution could be a smart option.
If a person’s finances have not been impacted by the pandemic, it’s a good time for them to throughly review their investment strategy. Knowing the fees associated with their 401(k) plan is important. Some older plans may have high fees, for example. An employee could improve their retirement savings plan by finding a better investment vehicle elsewhere. As mentioned above, this can be an excellent time to review one’s financial position and plans for a solid retirement.
If someone has lost their job at the company that sponsors their 401(k), it is almost always a good idea to transfer that 401(k) to a personally controlled IRA, which in many cases offer more investment options.
It is important younger people continue adding to their retirement finances, even if their employers don’t match their contribution in a sponsored 401(k). If the employer suspension is temporary, the employee, even if they have suspended contributions, can restart their contributions once the employer match begins again. If they have other instruments (IRAs, LIRPs etc) they should continue to contribute to those accounts.
Taking advantage of any instrument that allows compounded interest to grow cash value is always a good idea. As Einstein supposedly once noted, compound interest is a universal wonder.
A younger person may want to consider looking at other retirement investment options since they have the most time to make investments and plan their retirement. It is important that people recognize that just having the largest “war chest” at retirement can be for naught if they also have not also planned for the lowest costs, such as taxes, that will reduce their income in retirement.
Finally, for all retirement plans, it is critical to note that as times change, plans may need to change as well. Advisers and planners should be reviewing their clients plans no less than annually — and if they do not call on time, you should not forget to remind them.
R Allan Jensen