Outdated 401(k) Rules Are Shortchanging Americans

Age requirements and vesting delays may be costing you hundreds of thousands of dollars.

Many company 401(k) retirement savings plans could use a swift kick into the 21st century, according to a new report from the U.S. Government Accountability Office.

A number of longtime 401(k) plan designs fail to reflect a new, more mobile workforce, hurting employees’ ability to save, according to the report (PDF). Among the arguably outmoded practices: a requirement at some plans that workers be 21 before becoming eligible to join a 401(k), that employees finish one year of service before being eligible to join a plan and then wait an additional year to be eligible for company matching funds, and that employees wait up to six years before laying claim to all those contributions. 

Some of those practices save companies administrative hassles when workers leave after only a short time, and others help reduce turnover, employers and retirement experts told the GAO. But as the report notes, Bureau of Labor Statistics data show the median tenure for private sector workers in 2014 sits at 4.1 years, and federal data found that for workers aged 18 to 48, the average number of jobs held was more than 11 1 This was for the period from 1978 to 2012. .  

“Being ineligible to save in a new employer’s plan for 1 year on 11 occasions, especially occurring more frequently early in a worker’s career, may result in $411,439 less retirement savings ($111,454 in 2016 dollars),” according to the GAO’s projections.

Readers could take issue with some of those projections. The GAO assumed that someone works continuously from age 18 to 66 and that the stock market’s nominal long-term return will be 9.1 percent. It arrived at that by adding the Social Security Trustee’s projected annual trust fund real interest rate of 2.9 percent to an inflation projection of 2.7 percent, topping it off with an “estimated long-term premium of 3.5 percentage points.” 2 Indeed, that's 6.4 percent when you factor in inflation, but it's still a lot higher than many stock market experts are forecasting.  The GAO stresses that its report focused on a limited number of 401(k) plans—80 in total—ranging from ones with fewer than 100 participants to some with more than 5,000.

But many of the observations taken from the 80 funds were echoed in industry data from sources that included Vanguard Group and the Plan Sponsor Council of America. 

Here are a few other hypothetical price tags calculated by the GAO: 

The rules on vesting for employer matching contributions are now 15 years old, the GAO said, and “a re-evaluation of these caps would help to assess whether they unduly reduce the retirement savings of today’s mobile workers.” Seventy of the 80 plans in the GAO report hadn’t changed their vesting policy in the past five years. Vanguard data showed that more than 55 percent of its plans have vesting policies for matching contributions, with the most common being a five-year requirement.

Vesting policies may appeal to employers for reasons that aren’t immediately obvious. If an employee leaves before they are fully vested in an employer match, that forfeited amount of money can, and often does, go to either lessen the amount the company needs to contribute to the company match or to lessen employer expenses for the plan.

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(Corrects name of the Plan Sponsor Council of America in the sixth paragraph.)
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