Last-Day Rules - International Foundation of Employee Benefit Plans

Vol. 51 | No. 9 | September 2014
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HR professionals should understand the implications of waiting until year-end to deposit a
401(k) plan matching contribution into employees’ accounts.
Last-Day Rules: Are Some Companies
Going Too Far to Contain 401(k) Plan Costs?
by | Frank L. Giancola
I
n recent years, an uncommon and somewhat controversial 401(k) plan administrative practice has received a
considerable amount of attention from human resources
(HR) professionals, business leaders and governmental officials. The practice requires companies to deposit their 401(k)
plan matching contributions into employees’ accounts one
time per year. Traditionally, deposits have been made shortly
after employees make their payday contributions.
The practice is sometimes referred to as the last-day rule
since employees must be on the active employment roll on a
specified day at year-end to be eligible to receive the match.
Matching contributions are then deposited at the end of the
year or early in the following year. The contribution matches
part of or the entire amount employees have contributed to
the plan from their pay during the year, according to plan
rules, federal law and regulations.
The year-end match has received substantial visibility re-
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cently because of three well-publicized events, but it is too
soon to tell if we are seeing a transient spike in interest or the
beginning of a gradual change in the timing of these contributions. Because of the publicity the topic has received, stature of the players involved and effects the practice has on a
company’s costs and an employee’s retirement savings, HR
professionals should understand the implications of adopting it, as well as its prevalence.
Prevalence
It is estimated that 8-17% of companies are using the yearend practice, and reports of increased interest are mixed. Fidelity Investments, one of the nation’s largest 401(k) plan recordkeepers, reports that very few companies have adopted
the practice in recent years. Surveys by Aon Hewitt, another
major recordkeeper, show that 8% of 330 plan sponsors used
a year-end match in 2013, down from 9% in 2011.
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By contrast, 400 plan sponsors contacted in 2012 by Deloitte Consulting as part of its Annual 401(k) Benchmarking
Survey, which is co-sponsored by the International Foundation of Employee Benefit Plans and the International Society
of Certified Employee Benefit Specialists, showed an increase
in the number of companies using year-end matching to 12%
in 2012, up from 9% in 2011. A Plan Sponsor Council of
America survey of 299 plans found 17.2% of sponsors using
annual matching in 2012, up from an average of 13.3% from
2009-2011. These two surveys provide a better indication of
the practices of plans of various sizes than reports from Fidelity and Aon Hewitt, which are based primarily on plans at
large companies.
The three events that brought national attention to this
topic are described below.
IBM Adopts Last-Day Rule
In December 2012, IBM told its 90,000 employees that the
timing of company matching contributions to its 401(k) plan
would change from semimonthly to annually in 2013. To be
eligible for the annual contribution each December 31, employees must be employed on December 15, unless they retired during the year, in which case they would receive semimonthly matching contributions. This explanation was given
to employees regarding the change: “The percentage of the
IBM match and automatic contribution you receive—which
makes IBM’s 401(k) plans among the best in the industry—is
not changing.” After one year of service, IBM contributes 1%
of pay to all employees’ accounts, regardless of their savings
level, matches 100% of the first 5% of employee contributions
and immediately vests company contributions.
IBM’s plan is one of the nation’s largest with over $41 billion
in assets and 197,713 participants as of December 31, 2012.
The plan is ranked 16th best in the country by BrightScope, a
company that provides independent ratings of 401(k) plans.
Ratings are based on length of eligibility and vesting periods,
size of company contribution, participant fees, employee participation rates, number of investment options and other features (match timing is not cited as one of them).
Because of IBM’s size and reputation as a leader in offering a high level of employee compensation and benefits, the
change attracted substantial attention in the business media and the U.S. Senate. Because of its negative effects on an
employee’s ability to save for retirement, both senators from
Vermont, where IBM has a major operation, asked IBM to
reverse its decision, to no avail.
After about a year of little visibility, another major U.S.
company made headlines by attempting to make the same
change.
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AOL’s Failed Attempt to Adopt Rule
In early 2014, 4,600 employees of AOL learned that the
timing of the company match had changed to an annual basis from a per-paycheck basis effective January 1, 2014. The
company based the cost-saving action on the need to offset
rising health care costs caused by the introduction of the
Affordable Care Act and the $2 million spent on the medical care of two “distressed babies” of AOL employees. After
a firestorm of criticism from employees, AOL reversed and
apologized for its decision. After 90 days of service, AOL
matches 50% of employee contributions up to 6% of pay that
vest immediately—40% below IBM’s matching level of 100%
of the first 5% of employee contributions.
AOL employees appear to have been angered over the
change because of the rationale given by the company—
singling out the medical care costs of employees’ babies appeared to take advantage of someone’s misfortune—and the
fact that many learned of the change by reading The Washington Post.
A better context for cost reductions existed but was not
used. Earlier in the year, the company announced a 10% reduction in head count in an apparent effort to reduce employment costs, which gave it a logical opportunity to further
reduce personnel costs by changing match timing. To some
it appeared that AOL was simply following IBM’s successful
move, and it may have gone off uneventfully if the rationale
and announcement had been approached differently.
Newspaper articles indicate that other major companies
have a year-end match practice, e.g., Deutsche Bank, JP Morgan Chase, Morgan Stanley, Goldman Sachs and Charles
Schwab.
Massachusetts Secretary of State Gets Involved
In February 2014, the Massachusetts secretary of state
and chief securities regulator opened an inquiry into the annual match practice by asking the countries’ largest 401(k)
plan recordkeepers to provide the names of companies that
use the practice. Although the secretary does not have the
power to require more frequent contributions, he believes
that by making the information public, employees will be
able to make better decisions in negotiating their compensation package.
Whether states can pass legislation to require paydayassociated matching is unclear. Some states have somewhat
analogous laws to protect employees’ rights to just compensation at termination of employment. These states require
companies to pay terminated employees for unused and
earned vacation and to pay bonuses and commissions to employees who have earned them, in full or in part, but have
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been terminated before checks are distributed.
These events highlight a practice
that may become more popular because of the publicity and the fact that
a major company known for treating
its employees well, IBM, has made the
change. The negative publicity surrounding AOL’s announcement and
high-profile involvement of governmental officials have made it more
difficult to make the change without
arousing employee concerns. Without
this exposure, most employees would
perceive it as a minor change, since the
match continues and treatment at termination of employment is a distant
thought.
Its effects on the company and employees are outlined below.
Effects on Company
The annual matching practice has
the following effects on plan administration and associated costs:
• Cost savings. Companies experience a cost savings as employees
who terminate throughout the
year do not receive company
matching contributions for their
partial year of service. According
to a survey by HR consultants,
Compdata Surveys, the voluntary
turnover rate for all industries in
2013 was 10%. Companies might
reason that there is little value in
adding money to accounts of employees who are no longer members of the organization and soon
may be employed by a competitor. Companies also may be seeking to offset rising 401(k) plan
costs attributable to the recent
introduction of automatic enrollment and contribution increase
provisions.
• Use of funds. Companies can use
the money that would otherwise
be used for payday matching
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until year-end when matching
contributions are due.
• Plan administration. Plan administration is streamlined as employees’ accounts will be credited
with company contributions one
time per year rather than multiple times.
• Impact. Employees may be more
aware of a lump-sum match because of its size—as compared
with payday matches that occur
in small increments—and place
greater value on the matching
benefit as a result.
• Morale. The extent to which employee morale is negatively affected, if at all, depends on several factors, including corporate
climate, rationale for the rule,
level of 401(k) plan benefits and
whether a plan is new or established, as described below.
Effects on Employees
Annual matching has these effects
on employees:
• Retirement savings. Employees
will have saved less for retirement
by not receiving company contributions each payday and for partial years of work at termination
of employment. According to a
2012 study by the Bureau of Labor Statistics, baby boomers held
an average of 11.3 jobs from ages
18 to 46, nearly half of which were
held from ages 18 to 24.
As described in the February 14,
2014 New York Times article, “Beware
the End-of-Year 401(k) Match,” Vanguard estimated the effects of annual
matching on the amount employees
save for retirement in their career, using this hypothetical employee and taking inflation into account:
• 40-year career, seven job changes
• Starting salary of $40,000
• Pay raises averaging 1% per year
• 10% of pay contributed to plan
• 50% company match up to 6% of
pay
• 4% investment return.
An employee in a plan with semimonthly matching would have
$595,272 saved over a 40-year career.
An employee with year-end matching
would have saved $547,611—$47,661
less, based on receiving no match in
seven job-change years and a year-end
match in the other 33 years.
• Use of funds. Employees will lose
earnings and compounding on
fixed income plan investments
that occur when company contributions are made throughout the
year.
• Dollar cost averaging. Employees
lose the benefits of the investment strategy of dollar cost averaging that allows them to acquire
more shares of stock in a company when the price is low and
less when it is high. The strategy
requires the regular investment
of a fixed amount of money over
an extended period of time,
which occurs when company
matching contributions are made
each pay period.
Setting the Stage
Another important effect of the
change is a subtle change in thinking
about the discretionary aspects of an
annual match. Payday matching occurs automatically in small increments,
without any special effort by employees, all of which suggest an entitlement.
However, when the match occurs at
year-end in a lump sum, it begins to
resemble an annual bonus that is discretionary and usually depends on
the company attaining certain financial goals and employee performance
measures. The idea that the level of the
match should be tied to employee perseptember 2014 benefits magazine
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formance levels has been put forth by some advocates of pay
for performance.
Some companies have made the discretionary aspect obvious by reducing or eliminating company matching during
the past recession. Others, such as AOL, use the word discretionary to describe it in summary plan descriptions and
do not specify a matching level, only that the company will
periodically use one. For those that have not taken these
steps, the change in timing plants the thought that the match
is a discretionary payment and lays the groundwork for suspending or reducing it in the future.
Importance of Context
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As mentioned, the context in which the change to an annual match is announced is important when considering its
effects on employee morale. If a company falls on hard times,
other compensation programs are suspended or curtailed
and layoffs occur, employees will be more understanding of a
match delay. Companies that reduced the matching amount
during the recent recession had a logical opportunity then to
initiate the change.
IBM’s change was made in the context of salary freezes,
employee layoffs and special programs to encourage employees to retire early. IBM employees would tend to view it as
another action to reduce employment costs, not as an arbitrary act to chisel away at their compensation package. In
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Frank L. Giancola is a retired human
resources practitioner and college
instructor. He has more than 40
years of HR experience with Ford
Motor Company, Development
Dimensions International, Eastern
Michigan University and the U.S. Air Force.
Giancola has taught at Central and Eastern
Michigan Universities. He graduated with a B.A.
degree in psychology-sociology from the University of Michigan and received M.B.A. and M.A.
degrees in industrial relations from Wayne State
University of Detroit.
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companies that have a rich 401(k) plan, like IBM, the change
will not be perceived as a significant takeaway.
Finally, employers establishing a new 401(k) plan would
probably encounter little resistance from employees to yearend matching, as many employees would lack an established
reference point of payday matching for making judgments
about timing.
Terminated Employees—A Vulnerable Group
Another main element in the move to a last-day rule is
also important—the treatment of terminated employees.
One sign that this group has come in for shabby treatment
by some employers over the years is that states have enacted
laws to protect the rights of terminated employees. Many
states have strict laws regarding when terminated employees must receive their final paycheck for their final days of
work. Some have laws that require employers to pay terminated employees for unused and earned vacation, as well as
for sales commissions that have been earned but not paid.
It seems as though some employers have ignored the moral principle that if employees have done the work asked of
them, they are entitled to the compensation that goes with it.
There is no question that someone who terminates during the year has earned the matching contributions for the
part of the year he or she has worked, since those contributions are used to determine the amount of the employee’s
year-end lump-sum company contribution. IBM denied
matching contributions to employees who quit or were laid
off during the year but made contributions for those who
retired, as if the character of one group’s work was different from the others. Self-serving rules are being introduced
to deny individuals compensation they have earned, apparently due to pressure to reduce costs and a lack of laws to
prohibit it.
The idea of year-end matching has been planted in the
minds of many HR professionals and business leaders, and
it probably will appear in more 401(k) plans as they are
launched and amended in response to the need to contain
personnel costs. It is a slick move sure to be perceived as
smart management by many people.
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