Why 401k contribution as % of salary vs. fixed amount per pay check?

Question

I am wondering why some companies do not let their employee choose a fix amount per pay check as a 401K contribution. In my all jobs it has been always a % of my salary, so I will chose a percentage high enough to at least get the maximum employer contribution.

I was chatting with a colleague in my company, and in their previous jobs it was also the same way.

What is wrong with letting people chose a fix amount, so suppose some one wants to maximize they can just divide the maximum annual salary divided by pay frequency?

Answer 1

When I first started putting money into my 401(k) back in the 1980's the only options we had were by percentage. That was fine for me because I was interested in getting the maximum match, and I was never going to hit the annual maximum. Over the decades the maximum match percent started getting closer to the annual maximum. My income was also increasing and I wanted to maximize my contribution.Eventually I had to change the percentage during the year to try and come close the the annual maximum without going over.

More than 10 years ago those options changed. And in the companies I have worked for, and the ones my spouse worked for the option of either a percentage or an amount per check was available.

Ask your employer to see if the 401(k) trustee has that option. It might be an extra option available. It can help people trying to hit the maximum, or employees joining in the middle of the year, or ones using the age 50 or over catch-up provisions.

Answer 2

A variety of factors likely contribute.

Generally, companies want to encourage all employees but particularly lower paid employees to contribute as much as possible to their 401(k). Companies have to pass nondiscrimination tests in order to ensure that their highly compensated employees can actually contribute the max to their 401(k). These tests look at what percentage of salary lower-compensated employees are contributing and what percentage of salary higher-compensated employees are contributing. If highly compensated employees are getting "too much" of the benefit, their contribution limits get reduced. That is an outcome that companies try to avoid in part by convincing all employees to contribute more.

• Most people don't make a lot of adjustments once they do their initial enrollment. If you specify a percentage, your contribution rises automatically as you get raises. If you specify a fixed amount, you don't get the relatively painless automatic escalator. And once you factor in inflation, your contributions get smaller every year without intervention.
• For most people, 5% feels smaller than whatever fixed amount they would have to pick. It is psychologically easier for most people to save a few percent than to save a few hundred dollars every paycheck. This is doubly true when you're talking about pre-tax contributions where people are liable to compare their fixed pre-tax contribution amount against their after-tax take-home pay. If someone chooses to defer $500 per paycheck, they're generally thinking about what they could do with an extra $500, not what they could do with the extra $300 they'd have after taxes.
• If the employer provides any sort of financial education, that education is going to talk in terms of percentages of salary. If you're giving a seminar to a wide swath of employees, it is much easier to talk in terms of what percentage of salary most people need to defer to have a comfortable retirement than to talk about dollar amounts. Particularly when you have people in different positions making significantly different salaries.
• Employer matches are almost always phrased in terms of percentages which makes it much easier to suggest that everyone contributes at least enough to get the full match.
• People in the enviable position of being able to max out their contributions are generally much more comfortable doing the math to figure out what percentage to defer to hit that maximum contribution amount than rank-and-file employees are doing the math to, say, figure out how much they need to defer every paycheck in order to get the full employer match. If you're only going to have one option, percentage is the clear winner.

That said, plenty of employers and plans offer both options.

Answer 3

Most likely because many companies set up matching as "X% of your contributions up to Y% of your pay", so setting up a percentage to guarantee matching (rather than a fixed amount) is easier in these situations, and adjusts automatically as pay adjusts. How do you guarantee that you get the full match if your salary fluctuates?

Also setting up a fixed amount could result in a large proportion of one's pay being taken out if they have an unusually small paycheck in one period.

I don't think there's any laws or regulations that govern this - just policies that make it easier on the employer and many employees.

Answer 4

Last year at my company our 401K election was a dollar amount, and this year it was changed to be a percentage instead. I specifically asked HR why and was told that "studies have shown that employees will contribute more if they are given a percentage option instead of a dollar amount". I pointed out that if someone wants to max out their 401K it's much easier to do it accurately with a dollar amount, and suggested perhaps they could offer both. Again, the same clarified reply was they didn't want to do that because employees still contribute more when given a percentage instead of the option of both. (I ended with suggesting that there be a checkbox for those that wish to max out, and HR liked this idea for next year.)

Answer 5

1. To make the math for non-math inclined folks simpler. Employer matches are usually denoted as a percentage of the salary (e.g. up to 10% of salary), if you want to get all of that, and you’re expecting a raise mid-year...you would have to bust out Excel to make projections while 10% guarantees maximum whatever that amount is (on a pay period basis at least).

2. Keep data entry simple. One field to accept a percentage vs 2-3 fields needed to handle 1. Percent vs Amount, and 2. The actual number