This is the second in a three-part series on 401k retirement plans. In this article, we examine various and lesser known options that can make plans more meaningful for employees.
When employers started phasing out traditional pensions, 401(k) plans were introduced to fill in the gaps and have since become the primary retirement savings vehicle for many people.
While tax deductions and employer matching contributions are well-known benefits of these plans, there are other, lesser known perks of 401(k) plans, including after-tax savings options, financial resources and government protections.
Roth 401(k) option. When first created in 1978, 401(k) accounts had uniform provisions. All of them were funded from deductible contributions and required withdrawals in retirement to be taxed. However, in 2006, the Roth 401(k) was introduced.
The newer 401(k) plan does offer deductions for contributions. After-tax money is deposited into the account, and withdrawals in retirement are then tax-free. For younger workers who see significant gains in their investments over time, or workers who are in a lower tax bracket in retirement, a Roth 401(k) can mean substantial tax savings.
Similar benefits are offered through Roth IRAs, but there is one important distinction. Unlike Roth IRAs, the Roth 401(k)s have no income limit. Workers can also contribute more to a Roth 401(k) than a Roth IRA.
After-tax contributions. In addition to making deductible and Roth contributions to a 401(k), workers have the option of making after-tax contributions, which can provide an array of additional savings options.
The first option is a a "mega backdoor" Roth. In this, the government allows up to $55,000 in combined employee and employer contributions to a 401(k) each year for younger workers and $61,000 for those age 50 and older. Assuming someone has maxed out their tax-advantaged contributions, they could make up to $36,500 in after-tax contributions to a 401(k) depending on if and how much their employer matches.
Assuming it is allowed by the employer, this after-tax money can then be transferred to a Roth IRA so that future gains can be withdrawn tax-free. While only a certain percentage of American workers can afford to contribute at this level, it is a valuable tool for those able to use it.
There are also other after-tax contributions that offer employees a convenient option to build up their nonretirement savings. For instance, one national provider recently rolled out a feature that allows workers to make automatic after-tax contributions to their 401(k) plan that can be used to build emergency savings. This money can be accessed whenever needed, and any withdrawals of the principal amount can be made without having to pay taxes or penalties.
Financial safeguards. All 401(k) plans must comply with the Employee Retirement Income Security Act (ERISA). That means plan administrators can't push investments that maximize profits. Rather, they are required to ensure workers have access to stable funds with reasonable fees. They also must disclose information such as administrative expenses and historical fund performance to help employees make informed investment decisions.
Another benefit of ERISA is that it protects assets from creditors. In the event a judgment is entered against a worker, assets held in qualified funds such as 401(k) accounts cannot be garnished. This protection does not extend to certain government garnishments such as those for federal income taxes or criminal fines.
Automatic enrollment. The convenience of 401(k) plans is an often-overlooked benefit. Not only do payroll deductions make it simple to fund retirement savings, but many companies have also set up automatic contributions for new hires.
Nearly 70 percent of large employers now auto-enroll their workers in a 401(k) plan, according to a 2017 survey of 333 companies by the Benefits Solutions Firm, Alight Solutions. Nearly three-quarters of those firms will also automatically increase employee contributions over time. Though they offer a convenient way to put retirement savings on autopilot, employees can opt out of these contributions at any time.
Financial resources. Another benefit of 401(k) plans is the opportunity to obtain financial guidance. The Alight Solutions survey found 61 percent of companies offer one-on-one financial counseling and 60 percent provide online guidance.
If you are an employee thinking about a 401(k) plan, give us a call and we will advise you on choosing a plan that will help you make smart investment decisions, build emergency savings and provide valuable tax benefits.
Parts of this article excerpted from US News and World Report: http://bit.ly/2Sla7QW