For most working people, retirement planning is a daunting task if done alone. Whether someone likes their boss or not, a 401(k) plan through your employer can be the best chance of having enough savings to fund the retirement years.
Many companies provide 401(k) plans as part of their employee benefits package. But, many employees do not take full advantage to maximize their potential retirement benefits.
So, what is a 401(k)? For starters, the name is based on the section of the tax code that governs them.
“It’s one of many popular retirement vehicles,” says Rosalyn Brown, retirement business development officer at PNC Bank. “Basically, it’s a ‘defined contribution plan’ where the employee can define how much he or she wants to put into their retirement.”
The 401(k) approach arose during the 1980s to replace the older standard where the employer shoulders the responsibility of providing a retiree with a predetermined retirement benefit, i.e., 80 percent of salary upon retirement. With a 401(k) the employer can provide a contribution to a retirement plan, but is not obligated to do so. The method of contribution by an employer can vary from company to company.
A 401(k) plan is not just one-size-fits-all, Brown said. There are many ways to structure and customize a plan to fit any company. This includes the smallest small business to the mega company with tens of thousands of employees. The following are four ways 401(k) plans are a win-win for employers and their workers:
For the employer, a 401(k) plan offers a tax benefit because a contribution can be considered a business expense. If a company has excess cash at the end of the year and is looking for a business expense to offset paying taxes, instead of buying a truck or some other piece of equipment that you may not need, giving to your employee’s 401(k) plan, which in turn could benefit the owners up to the annual limit.
The employer can create a vesting policy, which is a time period that an employee must stay with the company before being entitled to the employer contribution. The vesting policy protects the company investment and provides the company a way to increase employee retention.
Why wouldn’t a company just provide employee bonuses if there is extra cash at the end of the year? Typically a bonus is heavily taxed like income and an employee could actually take home little more than half of the actual bonus amount. In addition to the employee tax, there is also employer payroll tax to consider.
If a year-end employer contribution is made to a 401(k) plan, the entire amount is put in the account and not taxed until the employee withdraws the money after retirement. Additionally, the longer the contribution sits in the 401(k) account, the more interest it can earn and can actually increase the value of the original contribution over time.
Generally, 401(k) plans are set up as trust accounts to protect the fund’s assets. Someone from the company, like the company’s owner or its human resources manager, may be designated as the trustee of the account. That person has to be aware of the fiduciary responsibilities associated with the trust account. They could be held personally liable if there is a problem with the 401(k) plan.
There are, however, financial firms that offer corporate trustee services, to remove the personal liability issue from an individual trustee. A company still has the ability to provide plan direction and guidance to the corporate trustee, but that trustee has a fiduciary responsibility to manage the plan in the best interest of its participants within the 401(k) rules and regulations. The company can outsource the plan’s paperwork, compliance testing, and employee education about investing and investment options.
You need a long-term view with retirement investments. A company benefit like automatic enrollment has become a popular way to administer a 401(k) program for both companies and their employees.
For plans with automatic enrollment, “We typically see employees going into their 401(k) plan sooner and at a higher rate,” Brown said. “We also see employees using automatic escalation, where 401(k) contributions are increased incrementally over time, that person will have more success reaching their retirement goals than someone who at the age of 45 or 50 starts to contribute the max.”
The 401(k) administration process is going through an evolution now. In the past, retirement funds were invested and managed by the employer on behalf of the employee. Now, employees are managing their own retirement funds by allocating their money into investments offed by their 401(k) plan. The results have been underwhelming.
“People are emotional about their money, whereas a company will typically look at the investment strategically,” says Brown. “Once people started looking at the returns that individuals are getting, once employees took over their own accounts versus when they were employer directed and companies were doing the investments on their behalf, the overall return is significantly lower.”
The company’s selection of “suitable” investment funds is crucial. While opinions vary about the selection of funds, diversification is key, she added. Having your company’s 401(k) plan investment options all come from one fund family may not be the best option vs. funds from multiple providers.
Brown said: “Just like everybody’s family, not all ideal people are in that one family. There is no fund family with all ideal funds either. It just doesn’t exist.”
Total Plans: 636,991
Assets: $5 trillion
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