Savings and Thrift Plans

Defined-contribution plans that link an employer's contributions to those made by an employee are known as savings and thrift plans. Employees generally specify the percentage of their compensation that they would like deducted from their paycheck and allocated to the plan. If the savings and thrift plan is also a 401(k) plan (most of them are), tax on those contributions is deferred.⁽¹⁾ Employers then match a percentage of participating employees' contributions. Approximately 40 percent of employees of medium-sized and large establishments and 18 percent of employees of small establishments were covered by savings and thrift plans in 2002.

The amount that an employee may contribute to such a plan is subject to limits imposed by statute and, frequently, to limits imposed by the employers themselves. As long as employers follow the prescribed nondiscrimination rules, they have full discretion to establish a formula for matching contributions by employees. The percentage of contributions that is matched by employers ranges from 25 percent to 100 percent, with 50 percent being the most common rate. The percentage of employees' compensation that is subject to the match is usually less than the maximum that employees are allowed to contribute: typically, 6 percent. Thus, an employee who contributed 6 percent of his or her salary to a salary-reduction plan would characteristically receive an employer's contribution of 3 percent. Employees who contributed more than 6 percent would still typically receive matching contributions from the employer of only 3 percent. One objective of capping the matching percentage is to skew the incentives for contributing away from highly compensated employees so that the plan does not run afoul of nondiscrimination rules.

A matching contribution rate is usually uniform for all employees--subject to the cap--but it need not be. Some employers vary the percentage according to their employees' years of service. Other firms reduce the matching rate for larger contributions. For example, they might offer a match of 100 percent on the first 2 percent of compensation that is contributed but only a 50 percent match on the next 4 percent. Furthermore, employers may modify the matching rate from one year to the next at their discretion.

As with other defined-contribution plans, funds contributed to savings and thrift plans accumulate investment earnings during an employee's years at the firm. Contributions are held in individual accounts rather than in a trust fund, and employees usually have considerable say over how those funds are invested. Furthermore, most savings and thrift plans allow participants to borrow against the balances in their accounts or to make early withdrawals in cases of financial hardship.