Sponsors ponder power of stretch matches

To stretch or not to stretch the match. That's the question plan executives often ask when redesigning their defined contribution retirement plans.

"We do get asked a lot about our thoughts on stretch matches for our clients," said Marc Howell, vice president of custom retirement solutions at Prudential Retirement in Philadelphia. "It's definitely something that plan sponsors are thinking about."

When employers "stretch the match," they essentially require employees to contribute more to their retirement plans in order to get the maximum employer contribution. Instead of, for example, matching employee contributions 100% up to a certain percentage of worker pay – say 4%, plan sponsors would match 50% up to 8% of pay.

The employer's maximum contribution would remain at 4%, but the employee would have to contribute twice as much to get it. Coaxing employees to contribute more while keeping employer matching costs the same is the goal behind the approach, a tactic that can work in some organizations but backfire in others, according to industry experts.

"Many people do think that stretch matches are helpful, and in the right situation they can be. However, they need to be designed with a lot of care to avoid accidentally hurting the very people you're trying to help," Mr. Howell said.

The use of stretch matches as a strategy to increase employee deferral rates stems from research showing that workers will use the employer's maximum contribution as an "anchor" to set their own contribution rates.

A paper published by the National Bureau of Economic Research in July 2012, in particular, gave momentum to the concept of a stretch match by showing the "match threshold," the rate at which employees must contribute to secure the maximum match, had a substantial impact on employee contributions, unlike the company's "match rate," which had only a small effect.

"Providing a match of 25% on contributions up to 10% of pay will induce individuals to save more than a match of 50% up to 5% or pay at a similar or lower cost to the organization providing the match," Brigitte Madrian, dean and Marriott Distinguished Professor in the Brigham Young University School of Business in Provo, Utah, wrote in the paper.

The match threshold, she said, likely served "as a natural reference point when individuals are deciding how much to save and may be viewed as advice from the saving program sponsor on how much to save."

By and large, employers implementing stretch matches appear to do so to sway employees to save more for retirement rather than to cut costs.

"There are a lot of employers who are looking at what their people are saving and are concerned," Mr. Howell said, explaining most workers are falling short of saving the recommended 12% to 18% of salary they should be setting aside annually for retirement.

While the motivation for stretch matches is generally well-intentioned, sources said, the move can be perceived as a negative by the workforce.

"It creates rumbling among the employees," said Gregg Levinson, senior director of retirement at Willis Towers Watson PLC in Philadelphia. "It forces employees to defer more to get to the same match they were already getting."

That, coupled with the fact that a stretch match might favor higher-paid workers with the means to contribute more, prevents many plan executives from moving forward on implementing match-stretching formulas.

A Vanguard Group Inc. study last year affirmed those concerns. The study, which analyzed 328 plans with match formulas that mimic or simulate a stretch match strategy, suggested those matches lower participation and deferral rates for non-highly compensated employees.

"The concept of a stretch match sounds good in theory. In reality, while it may be effective for some employers, it could be counterproductive for others, depending on their employees' financial ability to save," said Catherine Collinson, CEO and president of non-profit Transamerica Institute and Transamerica Center for Retirement Studies in Los Angeles.

Because of these concerns, many plan executives tend to shy away from stretching the match. In 2018, only 11.1% of plan sponsors implemented a stretch match with 13.3% planning to implement such matches this year, according to Callan LLC data. "It has to be positioned properly in the right organization, and I think then it could be incredibly successful," Mr. Levinson said. It might, for example, work in a pharmaceutical company where salaries tend to be high, but not in a highly unionized organization where there are many lower paid employees.

Mr. Levinson, for instance, pointed to a Willis Towers Watson entertainment and retail company client that wanted to implement a stretch match as a way to both cut costs and prompt employees to save more, but officials ultimately backed away from the idea. "They thought that their employees would see this as a take-away," he said of the client whose identity he declined to disclose.

In some instances, employers can be overly paternalistic, to the point of actually suppressing employee contributions, said Mr. Howell. He cited the example of a health-care organization that provided employees with a non-elective contribution of 5%, meaning employees would receive the 5% regardless of whether they contributed to their retirement account. In addition, the organization provided a 25% match on 4% of pay.

Non-elective contributions can sometimes suppress employee deferral rates because employees then mistakenly assume the employer is taking care of retirement for them, according to Mr. Howell. "They may not understand that they really still need to save over and beyond what the (employer) contribution is," he said.

The employer, which Mr. Howell declined to identify, decided to have employees put a little skin in the game to see if that would boost their savings rates. It implemented a hybrid stretch match that consisted of matching employee contributions dollar for dollar up to 3% of pay plus a 50% match on the next 7% of pay.

The new matching formula worked wonders in raising employee contribution rates. Prior to the change, fewer than 10% of participants were contributing 10% or more of their salary to the retirement plan.

Once the new match was in place, the percentage of employees saving 10% or more jumped to 34% within about a year, according to Mr. Howell.

Mr. Howell sees potential in stretch matches, provided they "don't stretch too far."

"When you start dipping under 50% as a match, there is a certain portion of the population that in essence throws its hands up and says it's not worth it to contribute ... for a match that is that watered down."

Then, participation rates start to decline, according to Prudential data he cited.

In addition, he does not advise asking employees to contribute more than 6% of salary to get the full match. Instead, he advises coupling the stretch match with auto escalation at 1% to 2% annually up to a maximum employee contribution in the 10% to 15% range.

It's better to use auto escalation than to "rip the Band-Aid off all at once and tell people they need to double their contribution," he said.