The Control Your Money: Own Your Life (™) Blog

September 6, 2024

National 401(k) Day is Here

Today, the Friday after Labor Day is National 401(k) Day. The creators chose the Friday after every Labor Day to raise awareness of the 401(k) so workers would “start the week with Labor Day and end the week with Retirement." (1) It’s a great reminder to all of us to review the benefits offered through our employment. As we enter the last quarter of the year, think about whether you have maximized the benefits from your employment, and whether you plan to make the same choices for 2025.

What is a 401(k)?

A 401(k) is a tax-deferred retirement plan offered through your employer. The term “401(k)” is a reference to the section of the Internal Revenue Code that governs these plans.

The funds are managed and invested through providers chosen by the employer such as Fidelity, Paychex, T. Rowe Price, Vanguard, and many others. Employees can choose to allocate their contributions among investments such as stocks, bonds, mutual funds, and other types of investments.

How does it work?

Employees can contribute a portion of their salary to their 401(k) plan annually through payroll deductions. The contribution reduces their gross income for the year. The taxes on the contribution and the accumulated earnings on the contributions are deferred until withdrawn. The earliest that the funds can be withdrawn without penalty is at age 59 ½.

The maximum that can be contributed annually is $23,000. An employee who is age 50 or older is permitted to contribute up to an additional $7,500, referred to as a “catch-up” provision to allow older workers to increase their savings as they approach retirement age.

Recently, employers have started to offer Roth 401(k)s which allow for contributions equal to the traditional 401(k) contribution, which is substantially higher than the Roth IRA allowances. However, as with a Roth IRA, the contributions are from after tax dollars, and the earnings accumulate tax-free, and can be withdrawn tax-free at age 59 ½ or older.

Benefits of a 401(k)

Employer match

Many employers match a percentage of the employee’s salary contributed to their 401(k). Based on some reports conducted by various 401(k) providers, employers typically match between 3% to 6% of the salary contributed to the 401(k) by the employee (single tier match). The match may be a full (dollar for dollar) or partial match.

Others may offer a two-tiered matching plan where the employer matches 100% of an employee’s contribution up to a percentage of the salary, and a different percentage for the next amount of contribution with a maximum cap on overall amount of salary. The earnings on an employer’s match is also tax-deferred and does not reduce the full amount of the contribution that the employee is permitted to make to his 401(k).

Here's an example of a single tier match:

An employee earns a salary of $50,000. The employer provides a full match of up to 6% of the salary contributed to the 401(k) plan by the employee or $3,000. In this case, if an employee contributes $3,000 to his 401(k) plan, he gets $3,000 from his employer. This is an amazing way to grow your retirement funds, where else would you get a 100% return on your money? If there is a partial match, of 50%, that would mean that on a $3,000 employee contribution, the employer would contribute $1,500, that’s a 50% return.

While an employee may not be able to afford to contribute the full $23,000 permitted, every effort should be made to contribute enough to capture your employer’s maximum match where possible. Make sure to check on your employer’s matching contributions. A related issue is when your rights to the employer’s contribution vests, in other words, how long do you have to work for the employer before you fully own the employer's contribution. It may be phased in, or fully vested after a number of years

Here's an example of a two-tier match:

An employee earns a salary of $100,000. The employer matches 100% of the first 3% of salary contributed by the employee, or $3,000, and 50% of the next 2% of salary contributed by the employee, or $2,000 with an overall maximum match up to $5,000. The earnings on the match are also tax-deferred and does not reduce the full amount of the contribution that the employee is permitted to make to his 401(k).

Portability

If you change employers or leave a job, you can roll the 401(k) funds into your new employer’s plan, leave them with the current plan provider or roll the funds into an IRA. A costly option would be to withdraw the funds because you will then have to pay the taxes due as well as a 10% penalty if you are not at least age 59 ½. Timing of rollovers may also be of concern. Your options may also vary based on how much you have in the 401(k), so be sure to talk to the benefits office or plan administrator before you leave your job.

Loan Source

An employee can usually borrow from his 401(k) account. The loan amount is typically limited to 50% of the vested amount up to a maximum of $50,000. This does not impact your credit score but must be repaid within 5 years. However, if you leave your employer you will have to repay the loan in a shorter period of time.

Exceptions to early withdrawal penalty of 10%

Withdrawals prior to age 59 ½ may be permitted without the additional 10% penalty under certain circumstances such as death or disability or, birth or adoption of a child. For a list of exceptions to the penalty for early withdrawal, you can refer to the IRS webpage: https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-exceptions-to-tax-on-early-distributions

Protection from creditors

Under ERISA (Employee Retirement Income Security Act), your 401(k) funds cannot be seized by judgment creditors. The exceptions include claims for alimony and child support, federal income tax obligations (not state and local income taxes), federal criminal fines and penalties, and certain criminal or civil judgments resulting from your wrongful acts involving your 401(k) plan. (2)

Advisors

A commonly overlooked and under-utilized benefit of a 401(k) is access to an advisor from the 401(k)-plan provider. If your plan makes an advisor available, make an appointment to meet to discuss your financial goals, how your funds could be allocated based on issues such as tolerance for risk, your age (how close to retirement), and other issues such as beneficiaries and how the 401(k) fits into your overall financial picture.

Employer contributions for student loan debtors

Beginning in 2024, employers may choose, but are not obligated, to make contributions to an employee’s 401(k) based on their regular policy when the employee makes payments toward student debt instead of contributions to the 401(k). For many employees, contributions to 401(k)s or other retirement plans have been derailed because of high student loan debt. Check with your HR or benefits office to see if this option is available, and make sure to check on the documentation requirements of the plan.

Retirement planning is essential, especially because social security is said to replace only about 40% of the average American’s employment income. The 401(k) may be one option to consider because of its advantages and the convenience that payroll deductions provide. More and more employers are automatically enrolling workers in 401(k) plans and setting the contributions by employees at 6% (3), with the result of more workers setting aside money for retirement and garnering more of the employers’ matching contributions.

(1) https://nationaltoday.com/national-401k-day/

(2) https://www.nolo.com/legal-encyclopedia/can-judgment-creditors-go-after-my-retirement-accounts.html

(3) https://www.wsj.com/personal-finance/retirement/company-401k-contribution-plan-six-percent-paycheck-0eb25703