When meeting with clients, I always ask about their 401(k) plan and exactly how it works. Many are familiar with the basics; they are investing X percentage of their pay, their employer is matching Y percentage, and they are invested in a portfolio that is based upon their age.
So what does it look like to take a deeper dive into the details of their 401(k) plan? To take a step back, let’s start with the 401(k) plan as a whole. All 401(k) plans are different and governed by something called an ‘Adoption Agreement’. This agreement can be 80 pages or longer, and details every aspect of how a specific 401(k) plan is to be operated.
It’s safe to say that anything that takes at least 80 pages to explain is going to be complex. Below are several important questions that I ask clients, why I ask them, and how this detailed analysis can help clients who save in a 401(k) plan.
What was your hire date and how many hours did you work from that date until the end of the calendar year?
Do you plan on leaving this employer anytime soon, and if so, what is the exact date you plan to leave?
I could argue that Vesting is the item I find incorrect most often when reviewing client 401(k) plans. Vesting is defined as the the time you need to be employed to be guaranteed all of the money your employer has given to you via a match or profit sharing contribution.
To be credited a vesting year, you typically need 1,000 hours of employment. Let’s take the example that you are a salaried employee. There are 52 weeks in a year, your employer is going to report 40 hours per week to your payroll provider, so there is a maximum of 2,080 hours per year.
This is where it gets tricky, your first year of vesting can be dictated on a calendar year, plan year, or anniversary year. Essentially, the date of your hire and the details of the adoption agreement will indicate when you will receive your first year of vesting.
The same concept holds true when you leave an employer, you need to have that 1,000 hours to be credited a vesting year. If you plan on leaving an employer in early June, it could make sense to hang around another few weeks to be credited another year of vesting.
In addition, 401(k) plans can incorporate something called an ‘End of Year Provision’ where you are required to still be employed on 12/31 in order to receive any employer contributions that were promised to you throughout the year.
Just these couple of questions and some simple planning can save significant dollars in otherwise forfeited employer contributions.
Does your company match your contribution per payroll, or at the end of the year?
An incredibly important item in a 401(k) analysis is the frequency in which your employer matches your contribution. Your employer can match your contribution each time you contribute, or they can look at what you contributed throughout the year, and make the required contribution after the year is completed.
Per payroll is preferred as the money gets into your 401(k) account sooner to be invested, and ongoing contributions can be dollar cost averaged into market dips. If your plan matches at the end of the year, you can take advantage of a 401(k) “True Up” if your plan allows. Here is an article I wrote about the true up, and how to maximize an employer contribution when it’s done once per year.
What types of contributions does your plan allow? Pre-tax, Roth, and/or After Tax?
Pre-tax – Most all 401(k) plans allow for this type of contribution. You make this contribution from your pay before taxes are taken out. Your contributions and earnings are taxed in retirement.
Roth – The exact opposite of pre-tax. Your contributions are taxed now, and those contributions and earnings are tax free when distributed in retirement.
After-tax – A hybrid of both pre-tax and roth contributions. These contributions do not count towards the 401(k) deferral limit of $19,000. A bit further down I will get to why after-tax contributions can play an important role for higher earners saving for retirement.
So why is contribution type important? The IRS imposes income limitations on individuals who want to save for their retirement. A single person making over $63,000 or a married couple making over $101,000 are limited on making pre-tax retirement contributions. The income limits for Roth contributions start at $120,000 for single filers and $189,000 for those married.
For 401(k) contributions, those limits do not apply. For high earning single filers and couples, the 401(k) plan may be the only way to save for retirement in a tax advantaged vehicle. In addition, there are maximums you can save in an outside IRA, which is $6,000 per year for 2019. The 401(k) plan allows for deferrals of up to $19,000 in pre-tax, and or Roth dollars.
Are you maxing your 401(k)?
If your 401(k) allows for it, you may be able to save after-tax dollars over and above your pre-tax and/or roth contributions. There can be several advantages to contributing after-tax contributions:
These questions help to cover a basic 401(k) analysis and can provide actionable planning items to help individuals fully take advantage of their company 401(k) plan.
I hope this information was helpful, and please do not hesitate to contact the office with any questions.