Your 401(k) match is billed as "free money," but high-income workers may be getting an unfair share

The 401(k) is now the most popular type of retirement plan, with many employers providing a company match when workers sock away money in their accounts. But these matches — often shorthanded as "free money" from your company— may exacerbate inequality in retirement, new research finds.

About 44% of employer matches are directed toward the top 20% of earners, according to a May study from researchers at Vanguard, Yale University and the Massachusetts Institute of Technology. By contrast, the bottom 20% of workers receive just 6% of their employers' matching contributions, the analysis found.

There's a lot of money on the line, as corporations provided about $212 billion in matching contributions in 2021, or almost 60 cents for every dollar saved by workers, the study noted. But the bulk of those employer dollars are more likely to go to higher-income workers, even though businesses typically dangle their 401(k) matches as a way to convince all workers, regardless of income, to save for retirement. 

"Employer contributions are a ripe target for innovation," the authors wrote in the report. "They disproportionately accrue to those with higher incomes, White workers, those with more access to liquid wealth and those with richer parents."

The findings come amid increasing scrutiny of the pitfalls of 401(k)s, which now serve as the predominant retirement vehicle for American workers. About half of all private employees participate in a so-called defined contribution plan, which include 401(k)s and 403(b)s, compared with about 15% who have access to traditional pensions. 

But even as they've supplanted traditional pensions, 401(k)s have left behind the bulk of America's workers, according to Teresa Ghilarducci, a labor economist and a professor at The New School for Social Research in New York. First, many workers lack access to them, and secondly, those who participate in 401(k)s are largely on their own to figure out how to invest and manage them, creating what Ghilarducci calls a "flimsy" do-it-yourself system.

After more than four decades of a 401(k) system, almost 3 in 10 older workers are nearing retirement without a penny saved. Two-thirds of younger baby boomers don't have enough saved for their golden years. 

Who saves — and why

To be sure, it's not entirely surprising that higher-income workers get a larger share of a company's matching contributions. For instance, take two workers who direct 10% of their pay into their 401(k)s, with the first earning $100,000 and the second earning $50,000. 

With a typical percentage match, where an employer matches 50% of an employee's contributions up to 6% of their pay, the worker earning $100,000 would get a $3,000 match; for the employee earning $50,000, the match would be $1,500.

But the analysis found that higher-income workers are actually getting a bigger share of employer contributions than their share of income — indicating that top-earning employees are enjoying outsized benefits when compared with lower-earning coworkers. 

In fact, the top 20% of earners get an 11% bigger share of employer contributions than income, while those in the bottom 20% get a 29% smaller share of matching dollars than income, the study found. 

That's partly because some wealthier workers are more likely to max out their savings, which helps them get the most in "free money" from their employers. But these people are also likely to have other advantages, like family wealth or a college degree, the study noted. 

At the same time, the analysis found that there's not a lot of evidence that company matches actually convince workers to save more. A majority of low-income workers don't participate in their 401(k) plans despite their company match, while most high-income workers are saving above the company's match cap, even though they may not benefit from any additional "free money," the study found. 

In other words, 401(k)s are giving more of a leg up to wealthier people who can afford to save more and max out their company match, while putting people who can't afford to save as much at a disadvantage, a previous analysis from the MIT researchers found. The end result is that wealth inequality is likely to persist, they concluded.

There is one type of 401(k) match that offers a fairer distribution of company dollars, the recent analysis found. This type of program is called a dollar cap match, which is only used in 4% of 401(k) plans. These programs cap employer contributions at a dollar amount, such as tapping out a match at $6,000 a year, regardless of how much an employee earns or contributes. 

And employers could add other attributes to help lower-income workers, such as immediate vesting, auto-enrollment and a higher default savings rate, the researchers noted.