Annual vs. Bimonthly 401(k) Contributions Tool

The Associated Press posted a story concerning IBM's effort to cut costs by switching from regular contributions to employees' 401(k) accounts on each paycheck to a lump-sum contribution at the end of each year. This move, clearly in the best interest of shareholders, has real and significant implications to the 401(k) accounts of IBM employees. According to the article, only a minority of companies use this type of arrangement.

"About 7 percent of employers offering 401(k)s make contributions once a year, benefits consultant Mercer estimates. About 88 percent make contributions each pay period, with a smaller number using monthly or quarterly distribution schedules." - AP

To get an idea of how an employee could be effected by this change, consider an employee with 25 years to retirement. Suppose the employee's current salary is $60,000 and that it increases 4% annually each January. Suppose the employee is paid bimonthly and on each paycheck the employee contributes 6% and the employer matches 6%. If the 401(k) account grows at a rate of 10% annually, then the employee will end up with an account value of approximately $920,000 at retirement.

If the employer chose to match employee contributions to the 401(k) annually instead of on each paycheck, the account value would be approximately $23,000 lower. Employees with more years to retirement stand to lose more: if the employee has 30 years to retirement, the difference is about $40,000. In each example, the difference amounts to about 2.5% of the 401(k) account value at retirement.

We have created a spreadsheet that models the effect of this change for several variable parameters such as years to retirement, salary growth, etc. It is available for download in Excel format down below.

Another reason IBM may be choosing this approach is that if an employee chose to leave the company before the annual contribution date, the employee would effectively give up the annual contribution. At a company with high turnover, those savings could be significant. In that case, much of the cost savings IBM would enjoy would be at the expense of departing employees and this move could be seen as a way to curb attrition.

Whatever the motivation, there is no upside for IBM employees. The cost savings or increased short-term cash flexibility will likely be significant (IBM has over 400,000 employees), but it comes at the expense of their own workers.