Congratulations. You have just landed your first job with great benefits including a 401(k) plan. And you know nothing about it. Most plans have a few things that are specific to the employer, however all plans follow the same basic structure.
Here are nine fundamentals for all 401(k) plans.
1. A 401(k) is a deferred compensation retirement plan. The employee is choosing to have some of their earnings withheld and contributed into the retirement plan.
2. A company (employer) must sponsor the plan. Employees only have access to contribute to a 401(k) plan if their employer has chosen to offer one. The company uses a financial services firm to hold the investments.
3. Employees have their own account. These are in their own name, never a joint account.
4. 401(k) contributions by employees are taken out of their paycheck. There is no option to give the financial firm an extra payment during the year. It is all through payroll.
5. Funds contributed by the employee are immediately available, though not to withdrawal without penalties and perhaps taxes.
6. Employers do not have to contribute into the plan. Some employers “match” employee’s contribution by putting a limited amount into employees’ accounts. It is not always available when an employee leaves the company as there may be a time frame before it is fully vested.
7. There is a limited choice of investments for most 401(k) plans. The employer coordinates with the financial services firm to provide a range of investments, typically mutual funds.
8. The IRS sets the employee contribution limits, not the employer. For 2019 it is $19,000. For those aged 50 and older, the contribution limit is $25,000. The projected 2020 contribution limit is $19,500 and $26,000 for older employees.
9. The company match amount is not included in the contribution limits set by the IRS. It is in addition to the employee limits. So, now that you have a basic understanding, sign up, save every paycheck and invest wisely.
Now that you know the basics, go ahead and get started now. You will thank your future self later!