What to do if your 401(k) match goes away

In today's age of layoffs, salary cuts, business closures, mergers, buyouts and bankruptcies, it's no surprise that the corporate 401(k) plan remains a target of budget-conscious executives. In particular, dwindling profits have forced companies of all sizes to rethink their matching contribution to retirement savings plans, leaving employees with an even greater personal stake in funding their retirements.

For many companies, slashing the matching contribution represents a "lesser-of-two-evils" approach to corporate downsizing. Executives see the reduction or elimination of matching 401(k) contributions, rather than the reduction or elimination of jobs, as the better way to trim budgets.

According to a recent study by Hewitt Associates,¹ companies can save an average of $1,500 per employee, per year, by suspending their 401(k) plan match. Assuming a match of 50 cents on the dollar, this translates to an average annual savings of $25 million for the typical large company, $10 million for a mid-size company and $2 million for a small company.

But as a study conducted by CFO Research Services revealed,² 87% of the executives surveyed believe matching contributions remain "very important" components of their 401(k) plans. The study also concluded that matching contributions are necessary for attracting employees into the company’s 401(k) program and for ensuring employees save enough for retirement.

Contribution cuts: A growing trend

According to the Pension Rights Center,³ hundreds of employers have announced plans to change or suspend their 401(k) matching contributions since the economy slipped into recession. This includes corporate titans such as Hewlett-Packard, Starbucks and JPMorgan Chase, as well as smaller organizations such as the Spokane Symphony, Lincoln Airport Authority and Denver Bookbinding Company.

Similarly, a recent survey of 283 U.S. companies, conducted by global audit firm Grant Thornton,⁴ revealed that 29% of respondents have modified or intend to modify their matching contribution features, and that two-thirds of those respondents will eliminate matches altogether. According to Grant Thornton's findings, health care and nonprofit companies report they are less likely to change their policies toward matching contributions while technology and retail/trade companies are more likely to implement changes.

A temporary cutback?

All the news on the matching contribution front is not dismal. Many companies that have suspended their matching contributions claim they will reinstate those contributions once the economy improves. Others say they will do so within the next six to 12 months.

Nevertheless, among the companies vowing to restore their matches, some are considering revamping the method by which they calculate their contributions. For example, rather than making yearly, flat-rate percentage contributions, more companies may implement a varying contribution process, giving them the flexibility to respond to tough economic times or performance shortfalls. This approach mirrors that of many smaller companies that tie their 401(k) plan matches to their firms' annual profitability.

Not required, but expected

Although not mandated by law, matching contributions from employers have become "standard fare" for many 401(k) plans. In fact, the Grant Thornton survey⁴ showed that 87% of respondents offered matching contributions to their plan participants prior to this year. Furthermore, Grant Thornton reported that the average company match is 50 cents on the dollar, up to 6% of an employee's salary.

Clearly, reducing or eliminating a retirement plan feature that employees have come to expect presents challenges. The "lost opportunity" can be huge. For example, losing a yearly employer contribution of $3,000, assuming a 7% annual rate of return, would mean an overall shortfall of nearly $123,000 over the next 20 years.

Making up the difference

For employees facing a cut in or elimination of their matching contributions, a revised saving and investment approach should be seriously considered:

• Don’t abandon your plan. Although the employer match is a key incentive driving participation in many 401(k) plans, it shouldn’t be the only reason you invest in your company’s retirement plan.

  With or without the employer contribution, a 401(k) plan still represents a valuable way to invest for retirement. In addition to reducing your taxable income, a 401(k) plan lets you take advantage of tax-deferred earnings and compounding. Over time, this can make a substantial difference in the value of your account compared to taxable alternatives. Plus, the payroll deduction aspect of an employer-sponsored plan makes contributing automatic and regular, a good discipline for investors.

• Boost your savings. Making up for the shortfall created by the loss of your matching contribution won’t be easy, but it’s an important step in securing your financial future.

  If you're not making the maximum contribution to your 401(k) plan, try to increase your contribution rate. You may even find that you can invest enough to make up for the full amount of the lost employer match — although with less take-home pay, you may need to reduce a few other expenses to stay within your budget.

• Open an IRA. If you’re already making the maximum contribution to your 401(k) plan, consider diversifying your tax-advantaged retirement savings with an IRA.

  You can contribute additional funds (up to $5,000 per individual, or $6,000 if you’re 50 or older, in 2009) to an IRA, regardless of whether you already contribute to a 401(k).

  If you meet the income requirements (less than $176,000 for married couples, or $120,000 for single filers**), a Roth IRA may be best. You can’t deduct your Roth IRA contributions, but you can withdraw your funds tax-free in retirement, provided certain holding period requirements are met.

  With a traditional IRA, some or all of your annual contributions may be tax-deductible, depending on your income level and whether or not you contribute to an employer-sponsored retirement plan. Withdrawals from a traditional IRA are taxable as ordinary income in retirement. Your financial advisor can help you determine which type of IRA is most appropriate for you and how much you should contribute.⁵

• Prepare for a Roth IRA conversion in 2010. In 2010, the $100,000 modified adjusted gross income limit to be eligible for converting a traditional IRA or qualified plan to a Roth IRA will be repealed, making everyone eligible for a conversion regardless of income or filing status. And because a Roth IRA offers enticing benefits such as tax-free growth and no required minimum distributions, it could be a valuable addition to your retirement savings plan.

  Talk to your advisor about the steps you should take now to prepare for a conversion in 2010.⁶

• Work toward other goals. Retirement probably isn’t your only long-term goal. You may want to accumulate money for a child’s college education or to launch your own business.

  Rather than making additional contributions to your retirement goal, you may want to beef up your efforts in other areas. This includes funneling more money into cash reserves to grow your emergency fund, which is essential in today’s climate. Also, building a diversified portfolio can help you achieve a variety of short- and long-term goals.

Your advisor: An important resource in challenging times

The current economic downturn is forcing many Americans to live with workplace cutbacks. When those cutbacks involve your retirement plan contributions, you may want to review your overall saving and investment strategy. Such a scenario provides an opportunity to get your retirement plan and your overall financial house in order.

As with any change in your financial situation, a modification to your 401(k) plan should trigger a phone call to your financial advisor. Your advisor can help you review your current financial situation and implement smart saving habits to guide you through the current downturn — so you're prepared for both the opportunities and challenges ahead.