The 401k plan has become the most popular retirement plan option amongst corporations over the past several decades due to the tax deferral capabilities and lower requirements on companies(compared to pension plans). 401k plans continue to evolve to provide greater benefits and features to their participants. However, if not communicated properly these oftentimes are easy to ignore by employees. Here are 4 features that have gained popularity, over the years, that plan participants may not be aware of.
1. Roth 401k
The ability to make Roth contributions to a company 401k plan has gain much popularity over the past 5 years and is being widely accepted by corporations. Roth contributions are contributions that are taxed at the time the employee places the money into the 401k. Since this money has already been taxed, the employee can then take a qualified distribution, after age 59.5, and the contribution plus the earnings will be tax free. This is especially beneficial for younger employees that may be in a lower tax bracket at the beginning of their career. Two things to note on Roth 401k contributions: 1. The employer match or profit sharing contributions will still be made in pretax dollars. 2. Even if you are over the annual income threshold to contribute to a Roth IRA, you can still contribute to a Roth 401k.
2. Automatic Increase
Automatic increase is a setting that 401k plans offer to automatically increase your contribution every year. The increase typically happens at the same time every year. The logic behind the annual increase is that it should line up around the same time that you receive an annual raise. Therefore, if your annual salary is going up you shouldn’t notice the increase contribution in your take home pay. The fact that this can be setup automatically prevents the friction of having to manual update this every year. This feature will allow you to stop the automatic increase once your contributions have reached a certain percentage (ie. 15%).
3. Automatic Rebalancing
In setting up your 401k plan you typically have a list of mutual funds and you select a certain percentage to go into those mutual funds. Over time as the market is fluctuating up and down those percentages will change. For example, if the stock market is up 10% then the percent of stocks in your plan will be overweighted from what you originally set it at. For younger employees this may not have too big of an impact, but for employees nearing retirement this can lead to them taking on too much risk. The automatic rebalancing feature can buy and sell your investments for you, to return your portfolio to the original percentages that you intended for them to be.
4. After Tax Contributions
After tax contributions are not a widely available feature in most 401k plans. The three types of contributions that are available are: pretax, Roth and after-tax contributions. These are three different buckets of money with different current and future tax consequences. Why would someone make after tax contributions to a 401k plan? This strategy can be utilized by high income earners and those that have a very high savings rate. The benefit of the after-tax contributions is that you can contribute above and beyond the typical maximum contribution limit. After tax contributions do not count towards the typical $19,500 (and $6,000 catch up) that is the maximum for pretax and Roth 401k contributions for those under 50 years old. What would be the advantage of having after tax contributions? A plan participant can use this money in two ways to drastically boost your retirement savings.
- By rolling this money into a Roth IRA
- By performaning an inplan Roth conversion
I will get into more details on this strategy in my next post.
If you have questions on your company 401k plan schedule a call here: https://calendly.com/johnbovard/30min
For more reading about establishing a company 401k plan check out this article: https://incline-wealth.com/2021/07/considering-a-company-401k-plan/