Is YOUR company 401(K) unfair? 'Free money' from employer contributions mainly benefits highest earners, landmark research reveals

The 401(K) retirement plan is designed to help workers build a nest egg by putting money aside from their pay check every month.

On top of this, they can receive extra money from their employer through a match. 

But new research suggests that these employer contributions are mainly benefitting the highest earners. 

Employers contributed $212 billion to retirement plans - roughly 58 cents for every dollar that participants saved - according to latest data from 2021. 

But some 44 percent of these funds went to the top 20 percent of earners, according to analysis from Vanguard Group. 

The lowest earners, meanwhile, received just 6 percent of the 'free money' from company matches, it found.

Research by Vanguard Group suggests 401(K) employer contributions are mainly benefitting higher earners

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It is not surprising that a greater share of employer matching dollars goes to those who are paid more, the study said, given that matching contributions are typically given as a proportion of salary.

But it suggests that those earning the most receive a larger share of contributions than their share of income.

The match formulas companies use vary. 

Some firms contribute a set amount each year, for example 3 percent of pay, regardless of whether the worker contributes. 

A small number of companies contribute up to a dollar cap - for example offering a 10 percent match on 6 percent of pay, subject to a limit of $6,000.

But the most common match formula, according to Vanguard, is a percentage match. 

Typically, this will be half of a worker's contributions up to 6 percent of their pay. 

When the employer contribution is based on percentage of pay, those with higher incomes typically receive more. 

But top earners also receive a larger share of 401(K) matching dollars than their share of income, the study showed.

On average, those in the top 20 percent income bracket received 39 percent of the income, but 44 percent of their employer's 401(K) contributions. 

Those in the bottom 20 percent of earners, meanwhile, receive a 29 percent smaller share of matching dollars than income, Vanguard found through analysis of over 1,000 plans between 2013 and 2022. 

Matching dollars often exacerbates pay inequity, said Fiona Greig, global head of investor research and policy at Vanguard Group

Matching dollars often exacerbates pay inequity, Fiona Greig, global head of investor research and policy at Vanguard Group, told The Wall Street Journal. 

One of the reasons higher earners receive a higher amount of employer contributions is because they are more likely to participate in 401(K) plans and earn enough to get a full matching contribution. 

Of the 10 most popular matching formulas, all but one disproportionately rewarded the top 20 percent of earners with a higher share of matching dollars than income. 

The study suggests that those earning the most receive a larger share of contributions than their share of income

The formula which is the best for more equally distributing employer contributions is when the funds are capped at a dollar amount, Vanguard found. 

Using a dollar cap formula, the top 20 percent of earners received around 33 percent of the matching contributions, compared to 35 percent of income.

Costco, for example, matches 50 percent of workers' annual 401(K) savings up to a $500 cap. 

The maximum workers can save into a 401(K) for 2024 is $23,000 - according to guidelines set out by the IRS - and $69,000 for combined employee and employer contributions. 

Those over 50 can also add an additional $7,500 in catch-up contributions.

The Vanguard research lays bare the divide at the heart of retirement in the US.

Research from Fidelity Investments earlier this month revealed a strong stock market means there are now more 401(K) millionaires than ever before.

The number of seven-figure 401(K) accounts rose to 485,000 in the first quarter of this year - up 15 percent from the previous quarter. 

A year ago, there were 340,000, according to the investment firm. 

Meanwhile, separate research earlier this year found a record number of Americans took money out of their 401(K) plan in 2023 for a financial emergency - as high inflation continues to wear away savings for many.