3 Tricks (and 3 Treats) in Your 401(k) Plan

Your employer’s 401(k) plan is a great place to get started with retirement savings. But how much do you really know about yours? If you haven’t taken the time to thoroughly scan your own 401(k) plan document, you’ll want to read on.

Below, we’ll look at three treats — as well as three tricks — you might find in your employer’s 401(k).

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Three treats

1. Your employer’s matching contribution

Many employers offer a company match for any contributions made to their 401(k) plan. Usually, the match will be described as “up to X% of total (or base) compensation.” The match typically ranges from 2% to 6%, though some employers may operate differently.

For example, if you earn $100,000 and choose to contribute $5,000 to your 401(k) plan in a given year, your employer will match up to $5,000 of contributions if their matching percentage is 5%. The employer match can be viewed as an immediate 100% return on your money, so it makes sense to take advantage of it when possible.

2. Tax-advantaged growth

If you opt for a pre-tax, traditional 401(k), you’ll receive a tax deduction for any contributions you make, and your money will grow tax-deferred into the future. This will enable it to compound freely — with no tax on growth or dividends — until you withdraw the money, ideally in retirement.

If you opt for a Roth 401(k), you’ll pay taxes upfront instead, but in return, you’ll receive tax-exempt status on the money for the rest of your life. This is an especially interesting option for earners in the 24% tax bracket or below who want to get their tax obligations out of the way now while enjoying the benefits of a tax-free retirement-savings vehicle.

3. 401(k) creditor protections

It’s not something you necessarily plan for, but if you ever found yourself in a bankruptcy proceeding, you’d be best served if you had most of your savings in a 401(k) plan. Employer Retirement Security Income Act (“ERISA”) protections shield employer-sponsored retirement savings from liquidation in bankruptcy, so it’s smart to utilize the plan to some degree.

IRAs and taxable accounts tend to be more “available” to creditors, so make sure you’re safeguarding some money in your employer plan.

Three tricks

1. Potentially high expense ratios

While this is becoming less of a problem than it used to be, there can be some sneaky underlying expenses associated with your retirement plan. Many 401(k)s come with unnecessarily pricey investment options, and some include frivolous administrative fees.

For the investment options in your plan, you’ll want to find the “expense ratio” associated with each choice, which is the fee you’ll pay to invest money in that particular fund. Attractive expense ratios run less than 0.15%, and some can be as low as 0%. However, many expensive investments can charge 1% or more.

If your plan is laden with miscellaneous charges or unusually high expense ratios, you’ll want to think twice about contributing the annual maximum if you have other options — like a Roth IRA or taxable account.

2. Matching contribution invested in company stock

Some plans will quietly invest matching contributions into company stock instead of investing it proportionally across your current investment allocation unless you tell your employer otherwise. This doesn’t seem quite right to me, because when the company does this, it is making a choice about your investments on your behalf. Unless you want money invested in your company’s stock — rather than broad-market, low-cost index funds — be sure to proactively correct this if it happens at your company.

You’ll need to actively monitor your 401(k) account and its underlying investments to ensure matching contributions are going where you want them to go.

3. Longer-than-usual vesting schedules

Vesting schedules require that you stay with your employer for a specified period of time before it will allow you to keep 100% of employer contributions to the plan. Many companies have vesting periods of between three and five years before your entire 401(k) is all yours. If you were to leave your job after say, one year, you’d only be able to take your contributions with you and would likely forfeit any amounts your employer put in.

It’s smart to question any vesting schedule longer than five years, as that is a particularly long term — especially in today’s increasingly flexible work culture.

Take the treats with the tricks in mind

The main idea here is to know what you’re getting with your company’s 401(k) plan, as many 401(k)s come with specific wrinkles that may or may not be to your long-term advantage. All plans are not created equal, so investing a few hours into learning about yours is a wise use of your time. In sum, while most 401(k) plans have advantages and disadvantages, a better understanding of yours is one of the keys to securing a comfortable lifestyle in retirement.

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