The Real AOL Story, Why Small Changes are Important

About a week ago I happened to view a two minute TV news blab on a change in AOL benefits that the CEO, Tim Armstrong blamed at least in part on the extraordinary expenses associated with two special needs babies. One of the mothers of the babies in question went public starting a typical media firestorm. The news story I saw had no content beyond the cry of a very angry mother.

A better understanding of this story is now appearing in the financial press and the blogosphere. According to a Newsweek article “Tim Armstrong’s Golden Parachute Vs the Cost of Distressed Babies” the author notes that Armstrong was specifically hired to get AOL operating costs under control. He has been successful. Under his watch the value of AOL stock has quadrupled. Tim Armstrong is handsomely rewarded for these accomplishments that naturally include layoffs. In 2012 he received $4.25 Million in salary, $2.76 Million in stock awards, and $5.1 Million in option awards. Given the context I assume option awards means performance bonuses. Including some other relatively minor benefits, his total annual compensation capped out at $12 Million. According to Armstrong’s unfortunate statement, “We had two AOL-ers that had distressed babies that were born the paid $1 Million each to make sure those babies were OK in general.”

Armstrong has apologized to the AOL employees and has backed off the proposed change to the company’s 401(k) plan. What was lost in all the brouhaha was the nature of that change. Armstrong was not cutting the size of AOL’s match to employee 401(k) accounts. He proposed changing the match from a per-paycheck match to an end of the year bonus. In a simple example, “Despite AOL News, 401(k) Matches Are Not Changing” from ABC News notes that in last year’s hot market a $1,000 match would be worth $1,245 by the end of the year. If AOL held on to that money until the end of the year they would get to keep $245 extra. If the employee quits before the end of the year, AOL gets to keep all of it. On the other hand such a plan would have saved 40% one year’s contribution in the crash of 2008.

There is one industry where end of the year bonuses have always been the norm, banks. Needless to say employees in this industry tend to wait until they receive their bonus before shuffling down the road to a better job.

How much would this cost the average AOL employee over their lifetime? According to Vanguard the average employee would lose about $50,000 in today’s dollars at retirement. A New York Times article, “Beware the End-of-Year 401(k) Match,” adds, “That buys a lot of trips to see the grandchildren-or scores of nights in a nursing home.”

This is not the first time a major corporation had this cost cutting idea. IBM did it last year. The New York Times article reports that two senators tried to pressure IBM into reversing this decision. IBM said, “No.” Since IBM offers its employees an unusually generous package of benefits including sizable 401(k) matches and the change wasn’t blamed on two premature babies, there wasn’t a lot of press coverage on this story.

I am including a link to the New York Times story because it includes an interactive retirement calculator that allows you to put in your current salary then play with contribution amounts, time horizons, and expected return numbers. This tool will show you that even small changes in behavior will result in very significant results over long periods of time. You will find the calculator about 2/3 of the way down the page.

Have fun with it.

Beware the End-of-Year 401(k) Match