Any 401(k) can aid in retirement savings. A superior 401(k) allows you to save significantly more.
The difference between a mediocre plan and an excellent plan could result in tens of thousands of dollars more in retirement funds in the future. In addition, the quality of a 401(k) can demonstrate a company’s commitment to attracting and maintaining talented employees.
That is not to argue that you should leave or reject a job if it lacks a solid 401(k) plan (k). But knowing how to identify a best-in-class retirement plan can assist you in evaluating job offers, negotiating a raise to compensate for what you lack, and possibly encouraging your employer to improve its plan.
Here are three qualities of excellent 401(k) plans.
A great 401(k) doesn’t make you wait to start saving
A excellent 401(k) includes an employer match, an abundance of low-cost investment options, and reasonable fees. A superior 401(k) does not require you to wait to utilize these benefits.
Numerous plans now permit participants to contribute instantly, without a waiting time. Others have one to six month waiting periods. Some employers impose a one-year waiting period, the maximum allowed by federal law, which can be costly for employees.
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Suppose you are 25 years old, make $50,000 year, and can donate 10% of your income. The $5,000 you can’t contribute the first year, along with an usual $1,500 match you wouldn’t receive, may result in around $106,000 less in your retirement account by age 65, assuming 7% annual returns on average.
If you change employment in the future — which you almost likely will — each waiting period could exacerbate the damage.
A superior 401(k) allows you to keep the match.
Plans offer a variety of matching formulae, the most typical of which are 50% of the first 6% of earnings and 100% of the first 3% to 6% of earnings.
The more liberal the match, the better it is for the participants, to a certain extent. The vesting periods for employer contributions in many plans are lengthy. For example, you may not be eligible for matching money until you have worked for the company for three years. After three years, you would own every match you’ve earned and every match you earn in the future.
A frequent alternative is a “graded” vesting schedule over six years. You may need to work for two years before receiving 20% of the match. You would receive an additional 20% after each year of service, until your total investment in past and future matches reached 100% after the sixth year.
However, lengthy vesting periods have been criticized for their harmful impact on the increasingly mobile workforce of today. According to a 2016 analysis by the U.S. Government Accountability Office, if an employee quit two jobs before to vesting between the ages of 20 and 40, the forfeited matches might be worth $81,743 at retirement.
According to Hattie Greenan, director of research and marketing for the Plan Sponsor Council of America, in 2021, 44.2% of plans will provide employees with instant ownership of matching funds, up from 38.5% in 2017.
You are always fully vested in your own contributions, but it’s crucial to understand any restrictions placed on your employer’s contributions – and perhaps advocate for shorter vesting periods.
A superior 401(k) provides you with more possibilities to save.
Most plans today provide a Roth 401(k) option that enables participants to save tax-free retirement funds.
Contributions to a traditional, pre-tax 401(k) provide an upfront tax deduction, but withdrawals are taxable as ordinary income. Roth 401(k) contributions do not reduce your current tax liability, but retirement withdrawals are tax-free. Financial advisors frequently advise clients to maintain funds in both pre-tax and tax-free accounts to better minimize their retirement tax liability.
In 2022, the IRS caps pre-tax and Roth 401(k) contributions at $20,500 for those under the age of 50 and $27,000 for those 50 and beyond. If the plan permits, however, combined participant and employer contributions may not exceed $61,000 for those under 50 and $67,500 for those 50 and older.
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Some plans allow you to make after-tax contributions, allowing you to put a substantial amount more money into your retirement plan.
Let’s imagine you’re under 50 and max out your pre-tax contributions. Your firm matches the donation, bringing the total to $26,500. If allowed by your plan, you might contribute up to $34,500 to the after-tax option to satisfy the combined employer and participant contribution limit.
Money in after-tax accounts can grow tax-deferred, which is a good benefit, but some plans provide something even better: “in plan” conversions that allow you to swiftly transfer the money into Roth accounts, so decreasing the possible tax payment. This combination of after-tax contributions and conversions is known as a “giant backdoor Roth,” and it can be extremely beneficial for accumulating tax-free cash for the future.
This piece was supplied by the personal finance website NerdWallet to The Associated Press. This material is provided for educational and informational purposes only; it does not represent investment advice. Liz Weston is a certified financial planner, columnist for NerdWallet, and the author of “Your Credit Score.”