There are many types of retirement plans available, the most common of which is the 401(k) retirement plan. Whether you’re an employee or an employer, it’s important to have an understanding of the details of the different 401(k) plans that are available. As an employee, you’ll want to know what the employer is offering before accepting a job.As an employer, be sure that the retirement plan you choose fits within your budget. The following is a guide exploring the essentials of a 401(k) plan and the importance of 401(k) plans.
Legally Speaking, is a Retirement Plan Mandatory?
There are no federal laws requiring employers to offer their employees a retirement plan. However, there are a few states that have implemented mandatory retirement plan laws. For example, California state law requires any business with at least five employees that does not have a retirement plan to enroll in CalSavers. Employees must be allowed to make paycheck contributions to their Secure Choice accounts with the assistance of a third-party administrator. But when it comes to 401(k) plans, there is no legal mandate requiring an employer to set one up for their employees.
As an employee, you are not required to contribute to a retirement plan even if your employer has set one up. You could, however, be automatically enrolled, which means that you need to opt out if you don’t want to make paycheck contributions to an existing retirement plan.
As an Employer, There Are Benefits of Arranging a 401(K) Plan
Although setting up a 401(k) plan isn’t legally required (and if you have less than five employees in California, you’re not required to enroll in any kind of retirement plan), it’s still a good idea to do so. There are a number of benefits to enrolling in a 401(k) plan that you cannot ignore.
Attract and Retain Quality Employees
Eventually, you’ll want to hire full-time employees that are highly skilled and experienced. When you have positions that require a lot of responsibilities and skills (and that are higher paying), you’ll find that the candidates who apply are less likely to accept any job offers you extend to them if you don’t offer retirement benefits. Remember, highly skilled workers are in great demand, which means that you are competing with other companies for their services. They are more likely to go with another company that offers good retirement benefits..
Encourages Employees to Stay
Hiring new employees won’t be your only challenge if you don’t set up a 401(k) retirement plan. The employees you currently have will be tempted to seek out greener pastures if they don’t currently have retirement benefits or if they receive a job offer that has superior retirement benefits. By setting up a 401(k) plan, your current employees will be more likely to stick around.
Shows Employees That You Care About Them and Their Future
Having a 401(k) plan isn’t just an incentive for new employees to accept positions at your company or for current employees to stay. It’s also a great way to build a strong relationship with your employees. By offering a 401(k) plan, you’re essentially telling them that you care about their financial future even after they’ve retired and are no longer working for your company. Your employees will be more motivated to be productive as a result.
There Are Tax Benefits
Employers are encouraged by tax benefits to help their employees save for retirement by contributing to their plans. For example, you may be eligible for a credit for upwards of 50 percent of the costs of setting up a 401(k) plan, up to $500 a year for the first three years. Additionally, every dollar contributed by an employer to their employees’ 401(k) plans is tax deductible.
As an Employee
It’s understandable that as an employee, you might be a little hesitant about deferring a portion of your paycheck to a retirement plan; after all, this means that you’re going home with less money in the short term. However, participating in your employer’s 401(k) plan will have long-term benefits that make it well worth doing.
A Safety Net For Retirement
While you can begin collecting Social Security retirement benefits once you retire, it most likely won’t be enough to live comfortably on. Many seniors end up taking part time jobs as a way to supplement their Social Security benefits. If you want to be financially secure when you retire, begin putting money towards your retirement now. By contributing to a 401(k) plan,your employer will be contributing as well (in some cases even matching what you contribute). This means that you’ll be getting extra money towards your retirement.
Money Aside for Emergencies
The money that you put into your 401(k) plan isn’t untouchable. Generally speaking, you can’t withdraw money from your 401(k) plan until you’ve reached 59 ½ years of age. If you do, there’s a 10 percent penalty for doing so. However, there are some exceptions, including if you’ve experienced sudden financial hardship. For example, you’re suddenly faced with paying significant medical expenses incurred by you or a family member. Or you may need to pay to repair significant damage done to your home (that insurance won’t cover), or pay for funeral expenses, just to name a few. If you’re faced with such a financial emergency, then you’ll be able to withdraw money from your retirement plan without having to worry about penalties.
401(K) Loans Not allowed
Some 401(k) plans have a loophole that allows you to access your retirement funds through a loan. When you take out a 401(k) loan, you’ll have to pay it back through deductions made from your paycheck and you’ll also have to pay interest on the money you borrowed. However, it’s worth noting that you cannot borrow from old 401(k) plans. It’s also up to the employer whether they will allow 401(k) loans or not when they set up their plan–many do not allow 401(k) loans because of the risk involved.
There Are a Few Different Types of 401(k) Plans
There are several different types of 401(k) plans. The following is a brief breakdown of the different 401(k) plans available to employees and employers:
Traditional 401(K) Plan
Traditional 401(k) plans are the most common type of 401(k). Traditional 401(k) plans allow employees to defer up to $19,000 a year. Employees over the age of 50 can defer an additional $6,000 in catch-up contributions. The employer can match up to the initial $19,000. The employer is required to do yearly non-discrimination testing and administration fees can be a bit expensive, which is why traditional 401(k) plans tend to be better suited for companies with at least eight employees.
This Plan Offers The Greatest Flexibility
Although discrimination testing is required and there are higher administration fees that need to be paid, the traditional 401(k) plan remains the most popular plan among employers because it offers the greatest flexibility. This is because the employer gets to decide how they structure their contributions (such as how much of their employee deferrals to match). Employers can also change or skip contributions year by year, which can be very beneficial if a company has a down year and they can’t afford to make large contributions.
Additionally, employers can set their own eligibility requirements. Finally, there are a number of brokerage options available through a traditional 401(k) plan that allows employees to trade in stocks and bonds.
Safe Harbor 401(K) Plan
A Safe Harbor 401(k) plan is very similarly structured to a traditional 401(k) plan. However one of the big advantages of a Safe Harbor 401(k) plan is that annual compliance testing isn’t required. These types of plans are best for employers that have high employee turnover rates or who risk violating yearly compliance testing.
Requires a Minimum Employer Contribution
Because of the lack of compliance testing, it will be easier for highly paid employees to maximize their contributions. However, employers only have two matching options. They can either match employee deferrals up to 4 percent (either dollar-for-dollar up to 4 percent or dollar-for-dollar up to 3 percent and then match 50 percent up to 5 percent) or contribute a total of 3 percent of the employee’s annual salary to their retirement account whether or not the employee decides to defer any of their paycheck to their retirement plan.
Savings Incentive Match Plan for Employees (SIMPLE 401(K)
SIMPLE 401(k) plans are best suited for small business owners (only businesses with fewer than 100 employees are eligible). No non-discrimination testing is required and contributions are nonforfeitable. Employers have two contribution options–they can contribute up to 3 percent of an employee’s wages if the employee chooses to defer some of their paycheck, or employers can contribute 2 percent of the employee’s annual salary regardless of whether they defer any of their wages. Employee contributions are limited to $13,000 a year (plus an additional $3,000 in catch-up contributions for employees over the age of 50).
SEP-IRA (simplified employee pension)
The SEP-IRA was designed for individuals who are self-employed or who run a business with no employees. Although employers can set up an SEP-IRA for their employees, they will be required to fund contributions for every employee that they have directly proportional to the amount that they contribute to their own plan. For those who do not have employees, an SEP-IRA is a very flexible plan since you can choose how much to contribute and even skip contributions on a year-to-year basis. Contribution limits are also very high (the lower of either 25 percent of your annual income or $56,000) compared to other plans and it’s easy to set up to trade individual stocks and bonds online.
Employers who offer a Roth 401(k) plan must also offer a traditional 401(k) plan. Employees can choose to contribute to one or the other as well as to both. A Roth 401(k) is almost exactly the same as a traditional 401(k) except for one major difference: instead of contributions being made tax-free, contributions are post-tax deductions. This means that the employee’s wages are taxed before they are deferred into the account. This means that when they withdraw money from their Roth 401(k), it won’t be taxed since it’s already been taxed.
It’s worth noting that even though contribution limits are the same as those on a traditional 401(k) plan, an employee can’t double their limits by choosing to enroll in both. The limits will remain the same whether they choose to contribute to one plan or both plans.
Which One To Choose?
There are many factors to consider when choosing a 401(k) plan, whether you are an employee or an employer.
As an Employer
Employers need to consider a lot of different factors when choosing a plan that will best suit their needs. For example, how many employees do you have? Some plans have higher administration costs. These types of plans are often better suited for larger companies. If you’re working with a budget, you may want to look at a plan with lower contribution limits and matching requirements. Startup companies will often consider plans where they can change their contribution structure on a year-by-year basis and where they can suspend matching contributions for a year if business hasn’t picked up yet.
As an Employee
How much you make and how much you can afford to put away for retirement are major factors in the type of plan you should look for when job hunting. Highly paid employees will want to make larger contributions, which plans like the Safe Harbor 401(k) plan are good for. However, most employers will typically have either a traditional 401(k) plan or a Roth 401(k) plan to choose from. As an employee, you can choose one or both of these. When choosing between the two, keep in mind that contributions on a traditional 401(k) are pre-tax, while those on a Roth 401(k) are post-tax. While it might seem like a traditional 401(k) would trump a Roth 401(k) for that reason, making deferrals into your account post-tax can help save money on taxes over the long term as your investments grow.
The investment types available in a 401(k) plan depends on the plan provider as well as on the plan’s sponsor (the employer). The investment types that can be included in a 401(k) plan include company stock (if the employer is a publicly traded company), individual stocks, bonds, securities, and variable annuities. No capital gains tax will be owed on the profits made from buying and selling stocks through a 401(k) plan, although the employee will owe income tax once they withdraw funds from their tax-deferred account.
Employers can set up vesting schedules to discourage employees from leaving the company after a short period of time. This means that the employee won’t have full access to the funds their employer has contributed until they are fully vested. There are three types of vesting schedules:
- Immediate – Immediate vesting means that the employee is fully vested the moment the employer makes a contribution to their account.
- Cliff – Cliff vesting means that there is a specific date on which the employee will become completely vested. For example, if the cliff vesting date is three years from the day the employee was hired, then the employer can take back the contributions they made should the employee leave or be fired before that date.
- Graded – Graded vesting means that the employee will gain partial ownership of the funds contributed by their employer by certain dates. For example, they may become 50 percent vested in two years and 100 percent vested in three years.
There are a number of different ways that an employer can contribute to an employee’s plan. This is often dictated by the type of 401(k) plan the employer chooses. The following are the four ways that an employer can contribute to a 401(k) plan:
Non-elective contributions refers to contributions that an employer makes whether or not the employee decides to defer any of their wages to their retirement account. A non-elective contribution is usually a defined percentage of the employee’s wages or a defined amount.
Matching contributions refers to contributions made based on how much an employee defers out of their paycheck. With a traditional 401(k) plan, employers have to make the same matching contributions for every employee. This means that if they match 50 percent of what one employee defers, they must also match 50 percent of what another employee defers. Matching contributions can be discretionary or can be dictated by the plan based on what plan the employer chooses.
Roth contributions are a little tricky. When an employee contributes to a Roth 401(k), their money is deferred after taxes have been taken out. When an employer matches what they’ve deferred, it doesn’t actually go into the employee’s Roth 401(k), it goes into a traditional 401(k). Essentially, an employer’s Roth contributions work the same way as traditional 401(k) contributions, except that they are matching the amount the employee deferred to the Roth 401(k).
Different plans have different contribution limits. This ensures that employees that make a significant amount of money don’t defer large sums of money as a way to save money on taxes. Retirement accounts are meant to be a way to save for retirement, they are not meant to be tax havens. Contribution limits also helps protect employers from having to pay an absurd amount of money into the retirement accounts of highly paid employees.
It’s important to note that both employers and employees will be responsible for certain 401(k) fees. There are three main fees associated with 401(k) plans. These include administrative fees, investment fees, and individual fees. Additionally, a commission is often charged for investments made through the plan. In some cases, the employer will pay the administrative fees, in others, the fees will be paid for by the employees from their plan’s assets. Individual fees are fees the employees must pay to use certain plan features, such as a hardship withdrawal. Full disclosure of the plan’s fees must be provided to the participants (employees) of the plan according to the law.
A Final Note: Other Points to Keep in Mind
There’s already a lot of things to keep in mind when looking at a 401(k) plan, whether you’re an employer or an employee. As an employee, make sure your employer offers a 401(k) plan of some kind. Consider what the investment options are, how much you can contribute, and how much your employer will match. But you should also consider how long you plan on staying with the employer. If you’re looking to move on to greener pastures after a year or two, double check to see if the employer has a vesting schedule in place.
As an employer, you’ll obviously want to consider a plan that fits your budget and that provides you with as much flexibility as possible. However, you’ll also want to make sure that it meets the needs of your employees and that it will be an attractive plan to job candidates. The bare minimum often will not do for job candidates who have multiple offers.
DATE: 2019-11-14 16:00:00
CATEGORY: Job Seekers