In early November, IBM made news by announcing it would end the company’s 401(k) matching contribution, effective at the end of this year. IBM’s 401(k) plan offered a generous dollar-for-dollar match on the first 5% of salary from employee contributions. IBM is replacing the 401(k) match with a 5%-of-salary contribution to a retired benefit account (RBA), which appears to be essentially a cash balance plan. IBM says funds inside the RBA will earn a fixed rate of 6% for the next three years.
Why did IBM do this? This change allows IBM to switch its retirement contribution from a defined contribution of the company to a defined benefit of the employee. At year-end 2022, IBM had $53 billion in defined benefit assets and an overfunded pension of roughly $15 billion. The change will free up substantial cash for the company since the 401(k) match required current funding, while the RBA contribution may not require funding, given IBM’s overfunded pension.
IBM was one of the first large companies to adopt the 401(k) in 1984, so it’s possible other large companies with overfunded pensions may follow suit and end company contributions to 401(k) plans.
If your employer terminates its 401(k) match, what should you do?
Revisit the asset allocation of your 401(k) contributions. If the company 401(k) match shifts to a cash balance-type plan, like IBM, then it may be appropriate to increase the equity allocation of your 401(k). Cash balance plans offer a fixed rate of return, so think of this account as delivering bond-like returns.
Under a 401(k), the employee controls the investment allocation of both their contributions as well as the company’s match. Under a cash balance plan, the investment allocation of the company contribution is now under their control. It’s not uncommon for the annual company match to a 401(k) to equate to roughly 25% of the total annual retirement contribution for an employee. With that 25% now locked into bond rates of return, participants may need to be more aggressive in how they invest their 401(k) contributions going forward.
Increase your employee deferral. If the expected return of your retirement nest egg is reduced because of more bonds in your portfolio, you may need to increase your contribution rate to meet your long-term goals. Let’s assume you’re 25 years from retirement with a current 401(k) balance of $100,000 and you’re contributing $20,000 a year to your 401(k) with a goal of $2 million. If you earn a 7% annualized return, you’ll be nearly $200,000 short of your goal. Increasing your contribution by just $2,000 a year gets you to your goal!
Consider a Roth IRA. Roth IRAs offer an excellent savings vehicle. Unlike a traditional IRA, contributors don’t receive a tax deduction, but earnings and distributions are tax-free (with some holding period requirements). While there are income limits for making direct Roth contributions, the backdoor Roth IRA loophole enables those with incomes over the limit to still make such contributions. Backdoor Roth IRAs can be tricky, so be sure to consult your tax or financial professional.
Now, more than ever, achieving retirement security requires constant vigilance. A benefit that many employees took for granted may soon disappear, so if you aren’t already maxing out your employer match, now’s the time to start.
Mike Palmer has over 25 years of experience helping successful people make smart decisions about money. He is a graduate of the University of North Carolina at Chapel Hill and is a CERTIFIED FINANCIAL PLANNER™ professional. Mr. Palmer is a member of several professional organizations, including the National Association of Personal Financial Advisors (NAPFA) and past member of the TIAA-CREF Board of Advisors.
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