If you are like 80% of U.S. workers (89% of those in companies with 500-plus employees), you have access to a defined-contribution plan, such as a 401(k). Because each plan is unique, it's important to find out about the details of your company's plan as well as your options. Here are five questions you should ask about your company's 401(k) plan.
- Contributing to your company's defined-contribution plan, such as a 401(k), can be a great way to save for your retirement.
- Be sure to contribute to the limit of your company's match—it's like getting free money.
- It's important to find out what your 401(k) plan's investment options are and which ones have the lowest expense ratios to make sure you are getting the best returns.
- Once you are vested in your company's plan, you can take your contributions, match, and earnings with you if you leave for another job or retire.
- Certain hardship exemptions, such as avoiding foreclosure, allow you to withdraw funds before age 59½ without paying a 10% penalty.
1. Does the Company Match My Contributions?
This is perhaps the most important question to ask because a company match can significantly increase the value of your retirement account. It's common for employers to match a percentage of your contribution. Let's say you make $50,000 a year and contribute 5% of your salary ($2,500). Your company matches 50% of your contribution, which adds $1,250 to your account. The employer contribution may be limited by the plan (for example, the plan may match 50% up to 4% of your salary), or by your annual contribution limit as set by the IRS.
Try to contribute at least up to the maximum of your company's match, assuming it has one. But you may not want to go above that amount. “Many small companies have high-cost 401(k) plans,” says Michael Zhuang, principal of MZ Capital Management in Bethesda, Md. “In this case, it is actually not worth it to contribute more to the plan, since whatever you save in tax dollars you pay in hidden fees and then some.”
2. What Are My Investment Options?
Plans will usually allow you to choose from a variety of investments, such as mutual funds, stocks (this can include your company’s stock), bonds, and guaranteed investment contracts (GICs). If you don’t like the investment options offered by your employer, you may be able to transfer a percentage of your plan into another retirement account. This is known as a partial rollover.
“Be sure to ask whether your 401k has a self-directed, full brokerage option. The majority of 401(k) plans don't, but some do,” says Dan Stewart, CFA®, president and chief investment officer of Revere Asset Management, Inc., in Dallas, Texas. “This would allow you to have a brokerage account where you could do individual stocks, bonds, mutual funds, ETFs, etc., and wouldn't limit you to the usual 10 to 12 mutual funds. Again, this is not the norm, but the larger the company, the better the odds of having a full brokerage option.”
Many people invest more aggressively when they are younger (and are able to recover from losses) and make more conservative investments as they approach retirement. This means you will likely change your allocations over time. Most plans let you make changes at will; however, some restrict changes to only once per month or quarter.
3. Which Investment Option Has the Lowest Expense Ratio?
Many investments, including mutual funds and exchange-traded funds (ETFs), charge shareholders an expense ratio to cover the fund’s total annual operating expenses. Expressed as a percentage of a fund’s average net assets, the expense ratio includes administrative, compliance, distribution, management, marketing, shareholder services, and record-keeping fees, as well as other operational costs. The expense ratio directly reduces shareholder returns, thus lowering the value of your investment. Don't assume an investment with the highest return is automatically the best choice. A lower-returning investment with a smaller expense ratio might make you more money in the long run.
4. When Do I Become Vested?
The vested portion of your 401(k) is the part that is yours to keep, even if you leave your job. Any money that you contribute is always 100% vested. The contributions made by your company, however, will be subject to a vesting requirement. There are two types of vesting schedules: graded and cliff. With graded vesting, funds vest over time. You may, for example, be 25% vested after your first year, 50% vested the next year, and so forth until you are fully vested. With cliff vesting, the employer contribution is 0% vested until you have been on the job for a specified amount of time (such as two years), at which point it becomes 100% vested. Either way, once you become fully vested, all the money in the plan (your contributions plus your employer’s) is yours and you can take it with you if/when you change jobs or retire.
IRS rules now permit hardship withdrawals from a 401(k) to include not just your contributions but also your company's match and earnings on these amounts. Check with your human resources department to determine your employer's policy.
5. When Can I Withdraw My Money?
In general, if you make a withdrawal before you are age 59½, you have to pay a 10% penalty tax (as well as income taxes) on the distribution. In cases of hardship, you may not have to pay the penalty. These hardship exemptions can include:
- Suffering a disability
- Death (the distribution is made to a beneficiary)
- Certain medical expenses
- Buying your first home
- Paying for college (for you, your spouse, or your children)
- Avoiding foreclosure or eviction
- Burial or funeral expenses
- Certain home repairs
Once you turn 70½, you need to make required minimum distributions (RMDs) from all your 401(k)s. (If you are still working for the company where you have one of your 401(k)s, you won't have to take an RMD from that one.) In general, you have to start withdrawing money by April 1 of the year following the year that you turn 70½. Your age (and life expectancy) and account value determine the required minimum distribution.
The Bottom Line
Choosing a 401(k) plan can seem overwhelming. As a result, many workers eligible to participate in these employer-sponsored retirement plans delay—or even avoid—signing up. Understanding these five questions will help clarify the plan's details and your options.
If the materials you get aren't clear, ask your human resources or benefits coordinator to answer any questions you have about your company's 401(k) plan. Be sure to ask, too, “what resources are available to support participants, such as online tools and applications, education, advising, and more,” says Marguerita Cheng, CFP®, CEO of Blue Ocean Global Wealth in Gaithersburg, Md.
If you're already signed up, be sure to track your investment options and reallocate as necessary.