What Does a 401(k) Generally Provide Its Participants?
Most 401(k) plans provide the same benefits to their participants. What are they and how can you maximize their potential?
If you’ve worked for a large company or even a small operation, chances are you’ve opened a 401(k) account. Provided by most employers, 401(k)s are the most utilized retirement savings vehicles out there. 401(k)s can have unique features that differ from others, but generally, 401(k)s provide the same benefits to all participants.
All 401(k)s provide benefits that are standard across all 401(k) plans. FTC and IRS guidelines have hard-fast rules that apply to every 401(k) plan. All 401(k) plans provide tax breaks, protection from creditors, and compounding interest. Additionally, most 401(k) plans offer an employer match and have solid investment options.
Let’s go into more detail about each of these features and also where to find your employer’s 401(k) plan features.
Perhaps the best feature a 401(k) can provide is an employer matching program. An employer match is where a company commits to match an employee’s 401(k) contributions up to a certain percentage.
The average employer match is about 3.5% of the employee’s salary. This means an employer will match every dollar an employee contributes to their 401(k) up to 3.5% of their annual salary.
For example, if you make $100,000 and contribute 10% or $10,000 of your salary to your 401(k) account, your employer will contribute $3,500.
An employer match is a great way to increase the amount of money you’ll have for retirement.
The IRS designates 401(k)s as tax-deferred retirement savings accounts. Tax-deferred means participants delay the tax obligation of the money they contribute to their 401(k) for a later date.
Being tax-deferred creates two benefits for 401(k) plan holders.
First, 401(k) contributions decrease your tax obligations for the year you contribute. Your 401(k) contributions reduce your taxable income, thus, decreasing the amount of taxes you pay during your working years. This could have the potential of lowering you into a lower tax bracket, significantly reducing the amount of taxes you’ll pay.
Second, by contributing to your 401(k) before you pay taxes, you’ll have a higher percentage of your money going into your 401(k). Using the above example, if you made $100,000, 10% of your pre-tax income would be $10,000. But if you pay taxes first, 10% of your after-tax income would be roughly $6,600—$3,400 less you’d contribute than you would with pre-tax earnings.
Shelter From Creditors
The Employee Retirement Income Security Act of 1974 (ERISA) was established to outline various protections to qualified retirement plans. One substantial protection established was from creditors and collection efforts.
Usually, collection agencies have the authority to garnish wages. In the case of federal loans like student loans, the U.S. Treasury can offset Social Security income and tax refunds.
However, due to ERISA protections, collections agencies can’t garnish any funds from a 401(k). Even if a judgment is placed through a court decision, your 401(k) funds will stay put.
If you die with an outstanding 401(k) balance, your 401(k) funds can’t be used to offset any outstanding debt either. As long as you have a designated beneficiary, the entire balance of your 401(k) will go to the intended recipient. If you don’t name a beneficiary, your 401(k) funds will to the estate and enter probate. There, the funds may be subject to offsetting any outstanding debt you have when you die.
Aside from the contributions you and your employer make to your 401(k), compounding interest is the most substantial factor that helps your 401(k) amass wealth.
Compounding interest is the practice of reinvesting the dividends or growth your investment account receives. This allows the subsequent periods to earn interest on your contributions and the earnings they received the previous period. This creates a compounding effect of earnings on top of earnings.
Many 401(k) plans compound each month.
Be sure your 401(k) has opted into reinvesting your dividends. If not, your earnings could be placed in a cash account within your 401(k) uninvested. These cash accounts are glorified savings account but don’t earn any interest.
Solid Investing Options
Most 401(k) plans offer a good selection of various funds which to invest your money. The average 401(k) plan provides about 19 different investment funds for participants to choose from.
The most common fund 401(k)s are invested in is a target-date fund. Many 401(k)s use target-date funds as their default investment fund. A target-date fund is comprised of stocks and bonds and reallocates the funds based on how close the account holder is to retirement or their “target date.” As you near retirement, the fund moves a more significant percentage of your retirement funds into less risky bonds.
If you want more control over your 401(k), you can opt to invest your money into mutual funds, index funds, or bond funds. You can set your preferred investment fund, so your contributions are automatically deposited into that particular fund.
How to find what your 401(k) plan provides.
When you first join your employer’s 401(k) plan, you’ll receive a summary plan description. The summary plan description outlines all of your 401(k) plan’s features, rules, and benefits.
If your plan offers an employer match, you’ll find how much they will match and when their contributions will be fully vested. If your employer’s 401(k) plan offers 401(k) loans, the details and loan terms will be outlined in the summary plan description as well.
Because many plans change the various investment funds they offer, they are laid out in the summary plan description. Alternatively, if your plan has an online portal that provides access to your 401(k) and the plan’s investment options, you can research the individual funds. This allows you to know what you’re investing in fully and if it meets your financial goals.
When in doubt, contacting your human resources department or your 401(k) plan’s administrator is your best bet to get the full details of your 401(k) plan.
Don’t lose your 401(k)s!
Another feature of 401(k) plans is that they are transferable. This means when you leave a company, you can rollover your 401(k)s into your new employer’s 401(k) plan. If you aren’t eligible for your new 401(k) plan yet, you can roll over your old 401(k)s into an IRA at an outside institution.
Leaving behind your 401(k)s when you quit can lead to you losing track of your retirement savings. This can lead to your old employer distributing your 401(k) funds elsewhere, making it harder for you to track down.
If you’re not sure how to find your old 401(k)s, start by contacting your old employers. If that doesn’t help, hire some help. It’s essential you don’t lose track of your 401(k)s as it can lead to you losing them forever.