Is 401k matching unfair to lower-paid employees?


From the employer to employee relationship perspective, one could argue that no, it is not unfair to have percentage based matching, at least by comparison to the fact that oftentimes bonuses and raises are also granted as a percentage of salary.

However, unlike other tax advantaged perks, such as employee 401k contributions, HSA, FSA, and insurance premiums, all of which generally have the same tax advantaged limits for every employee, employer matching 401k contributions differ in that the amount of the tax advantaged funds effectively increases based on salary. (Note I say "effectively" because the upper limit of $57K exists for everyone, but is unattainable by most because there is typically no mechanism to contribute that much even if you have the money to do so). Note the matching amount is capped based on salary. For 2020 the cap is $285K, which means anyone who makes more than that will receive the same company matching as someone who makes exactly $285K.


There are a series of tests that 401(k) programs have to go through. They are looking to make sure the polices of their 401(k) program do not discriminate against lower income employees. If they fail those tests they have to fix the issues:

If your plan fails the ADP or ACP test, you must take the correctiveaction described in your plan document during the statutory correctionperiod to cause the tests to pass.

The plan has 2 ½ months after the end of the plan year being tested tocorrect excess contributions. The plan can distribute excesscontributions any time during the 12-month period. If correction isnot made before the end of the 12-month correction period, the plan’scash or deferred arrangement (CODA) is no longer qualified and theentire plan may lose its tax-qualified status. You may correct thismistake through EPCRS. If the employer doesn'tdistribute/recharacterize excess contributions by 2 ½ months (sixmonths for certain EACAs) after the plan year of excess, the employeris liable for a 10 percent excise tax on excess contributions.

The tax doesn't apply if the plan sponsor makes corrective qualifiednonelective contributions within 12 months after the end of the planyear if the plan uses current year testing. However, if the correctivecontributions are insufficient for the CODA to pass the ADP test, thetax applies to the remaining excess contributions.

There are two different methods to correct ADP and ACP mistakes beyondthe 12-month period. Both require the employer to make a qualifiednonelective contribution to the plan for NHCEs. A qualifiednonelective employer contribution (QNEC) is an employer contributionthat is always 100% vested and subject to the same distributionrestrictions as elective deferrals.

Companies have options to avoid getting into this situation. They can auto-enroll new employees. They can tweak the matching rules to encourage more participation. I do know that automatic vesting at 100% helps participation.

I am not sure if all this is done because you have to entice the lowered paid employees to participate because the general matching rules are unfair; or it is just harder to get younger employees to participate in a plan that they don't get access to for 30 or 40 years.

I do remember that when I was younger, I didn't look at it being unfair that higher paid employees saw a bigger match on a dollar basis. The ideas that I had to overcome before starting with the 401(k) were the risks in investing, and the decades delay in getting access to the funds.


Does that mean lower paid employees get less of a perk?

Yes: when looking at the financial value of this kind of 401(k) matching, lower paid employees receive less money from their employers for this perk than employees with a higher salary