While workers of generations past enjoyed pensions that paid out a certain amount until death, today’s career employees have a variety of options to save for retirement, both inside and outside of employer-sponsored plans. Changing careers or positions several times is commonplace nowadays, and retirement savings plans have evolved to reflect the habits of the workforce. A 401(k) is a popular plan offered by many employers who provide retirement benefits for their workers. These plans are an effective way to attract employees, entice workers to save for retirement and offer a variety of savings options with little management hassle.
Setup and Types
While all 401(k) plans allow employees to contribute pre-tax earnings in order to save for retirement, there are three sub-sets of these plans that have differing levels of flexibility.
Traditional plans are the most common and flexible among the options. Employers may contribute set amounts, match a portion of employee deferrals or leave the funding entirely up to the employee. Companies also have the option to set up a vesting schedule that specifies when employer-added money becomes fully owned by the employee. These plans are subject to annual testing to confirm that all employees, regardless of rank, are receiving their lawful benefits.
Safe-harbor 401(k) plans allow employers to skip annual testing in exchange for a certain level of guaranteed employer contributions for all participating employees. These contributions are vested immediately, even if the person quits or is dismissed.
The third type of plan, the automatic enrollment 401(k), permits employers to withdraw funds from employee wages and invest them in a certain set of default investments. Individuals can elect to change investment options or to decline participation, but they must take action to do so. These plans generally increase participation among all classes of workers.
While employers can set up plans on their own, many choose to use the services of a bank or investment company. To set up a 401(k), employers must draft a written plan, establish a trust to hold plan assets, launch a record keeping system and provide details to eligible workers. Eligibility requirements must be the same regardless of position, although federal regulations allow for the following exclusions:
- Some nonresident aliens
- Employees who have completed less than one year of service
- Workers under the age of 21
- Individuals covered by a collective bargaining agreement that disallows participation
Choosing a reputable firm to set up and manage a retirement plan limits liability and often allows for a wider range of investment options.
Benefits for the Employer
The pensions of years past were very expensive to fund and administer, which is why so many employers have flocked to the 401(k). While pensions were largely funded by the employer, a 401(k)’s main funding source is the employee. Some employers opt to match employee contributions up to a certain percentage to both attract employees and encourage them to save. Individuals are free to add funds above the match up to the amount allowed by tax law.
Funds contributed by the employer are tax-deductible for the business. Employees control their own tax situation by increasing contributions. Some plans also allow workers to make ROTH contributions, which are taxed on the way in, but can be withdrawn tax-free.
Fees and Management Costs
All plans are not created equal and much of this is due to fees and management costs. The expense of initial setup lies with the employer, but much of the burden of ongoing management is shouldered by plan investors. Investment companies often asses a yearly or quarterly fee to each account for the management of the plan and any services provided, such as yearly evaluations for participants.
Additionally, each investment option will have associated fees, which can range from small to substantial. Offering a variety of low-cost investment options is key to encouraging plan participation and allows people greater control over their retirement earnings. A 401(k) offers tax benefits and other benefits to both employers and employees.
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