Your Guide to a 401(k) Retirement Plan

Your Guide to a 401(k) Retirement Plan

As 401(k) retirement plans take over traditional schemes, it is important for employers and employees to understand how this investment works. Most employees across the US depend on it for their secure future. In fact, over 75% of the USA employees have agreed that their company’s retirement plan is their only source of savings. Hence, the 401(k) plan shows the employer’s commitment to the workforce while supporting higher recruitment and retention rate. 

Although this retirement program offers various tax benefits, it has a daunting and complicated landscape. One has to deal with several options, fiduciary and administrative responsibilities, and more for its effective implementation. Yes, companies are using HR software solutions to educate employees about it and make the enrollment process easier, it is still necessary how this plan works. It will help employees choose the right plan without the hassle and put all the things in the right place. 

We have breakdown different aspects of the 401(k) retirement plan for beginners, employers, and employees to help them start planning and saving for a comfortable and secure retirement. Take a look:

What Is a 401(k) Plan? How does It Work?

A 401(k) is a qualified retirement plan that is sponsored by employers to help employees save for their retirement. It is a pre-tax contribution which means that an amount is automatically withdrawn from employees’ paycheck and invested before the income tax is deducted. The funds are invested in employee’s choosing from the available offerings. 

Among the two types of employer-sponsored retirement plans- defined benefit plan and defined contribution plan, 401(k) is the former one while pension scheme is the latter option. For those who are taking their first step into retirement schemes, collecting and understanding the relevant information can be confusing. Hence, putting it simply, 401(k) is a contribution that you make out of your salary to the account annually. The amount you put into the account is invested so you earn a higher amount of interest over time. The main benefit of this plan is that there is no initial tax of earnings but you are taxed only when you withdraw the amount after retirement. 

Employers offer a 401(k) plan and open account for their employees. Not all companies offer this retirement program and some require employees to work with them for a specific period before they qualify. Also, employees have to enroll themselves in a company’s 401(k) plan which means that they create an online account and choose the amount they must contribute. However, it is now common for employers to automatically enroll their employees who choose a particular percentage to be taken out of their paycheck and sign up for automatic deductions. They can choose to invest in stocks, mutual funds, and bonds as well. 

Based on the type of plan and details, the money invested can be tax-free and the same amount is contributed by employers. Also, the tax break comes either when the money is contributed or when employees withdraw the amount after retirement. 

Common Features of a 401(k) Retirement Plan

In addition to the detailed explanation of 401(k) above, there are other common features of this program that you must know:

Automatic Enrollment

A key feature to make the retirement plan successful and effective for employees is by allowing employees to enroll in the plan smoothly. The entire process should be simple and short as employees usually prefer to maintain the same benefits plan in an easy year.

Tax-free Contribution

Every employee wants to reduce taxes and this is exactly what the 401(k) plan does. The amount invested in a traditional 401(k) is contributed on a pre-tax basis and the savings are a function of the tax rate. 

Employee Retirement Education

It is important to educate employees about the company’s retirement plan and all the related details because it helps them make informed decisions as participants. Employers must arrange for outcome-based education sessions that are easily available online. It should be attached with short videos for better learning which are accessible even at home so they don’t disrupt the workplace. 

Easy Access to Money

As 401(k) offers tax benefits for contribution, employees cannot touch the money until they reach a certain age. However, considering limited circumstances and situations, one can access the amount sooner, and that too penalty-free withdrawal at the age of 55. If employees leave the company that sponsors this plan, then they can easily get the money. This flexibility is not allowed in IRAs. 

Qualified Default Investment Alternative (QDIA)

This feature offers investment selection for employees or participants who haven’t make a choice and offers fiduciary protection to plan sponsors. 

Benefits of a 401(k) for Employers and Employees

A 401(k) plan offers some exclusive benefits for employers and employees that are hard to find in other retirement schemes and programs. We have outlined a few of them below:

To Employees

Employees can save pre-tax dollars with 401(k) while they are working and can enjoy several financial benefits as well. They don’t have to pay taxes on the amount they invest until they decide to withdraw the money when they retire. 

Also, the contribution is not counted as income. By the time they need the money for their retirement, it is expected that it will be included in a lower tax bracket which will generate long-term tax savings. 

The savings on 401(k) grow tax-deferred as long as it is a part of this plan. Hence, you can compound your earnings.

Many employers offer to match employees’ contributions up to a set limit. They can either choose a percentage of employee contributions or opt for a certain dollar amount irrespective of their salary.

To Employers

The plan expenses are tax-deductible to the extent that the contributions don’t exceed a certain limit.

All the advances in payroll integration and recordkeeping make this entire 401(k) plan implementation and maintenance affordable for companies.

Investment gains and elective deferrals are also not taxed until distribution.

Offering a 401(k) retirement plan along with other benefits helps employers and HR professionals attract top talent while reducing turnover. As employees invest to save for their future through this scheme, they are less likely to leave the organization, especially when employers’ contribution provides an added value to the total compensation. 

Setting Up and Executing 401(k) Plan

If the plan is not executed or set up well, then it won’t provide any value or benefit. Therefore, you must take care of two crucial factors- administration and compliance. Here are a few tips to maintain the plan throughout:

Start by diligently researching third-party administrators who provide record keeping and other services for 401(k) plans. Make sure to include only established and well-reputed companies in your list and ensure that they serve your employees long-term with all the necessary resources. 

Engage your employees as you roll out a plan by conducting open enrollment meetings. It can be virtual, in-person, or via any platform but make sure to educate them through articles, webinars, and other resources so they can select the most beneficial plan for themselves. Also, let them know what they have to pay to avail of this retirement scheme. Use employee self service portal so they can access and update their information and keep the language of all the documents easy. 

While implementing a 401(k) retirement plan in your company, you have to deal with fiduciary obligations and must adhere to the legal requirements. Yes, you will have a recordkeeper to complete annual reporting and compliance-related activities but the ultimate responsibility is on you to ensure that all the rules are followed. 

Setting up an effective 401(k) plan as a part of your comprehensive benefits package is a win-win situation for your employees and you. It helps them save for a secure future while supporting the tax needs and also assists companies to attract and hire the best candidates. So, if you still haven’t introduced this plan in your organization, it’s time to evaluate your employee benefits programs and include 401(k) in them.

Author’s Bio: Alicia works with the editorial team of Accomplish EP, a leading company offering employee benefits software. Exploring the latest technologies, reading about them, and writing her views have always been her passion. She seeks new opportunities to express her opinions, explore technological advancements, and document the details. You can always find her enjoying books or articles about varied topics or jotting down her ideas in a notebook.