How to Spot a Great 401(k)

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Any 401(k) can help you save for retirement. You can save a lot more with a great 401(k).

The difference between a mediocre plan and a great plan could result in tens of thousands of dollars in future retirement money. Additionally, the quality of a 401(k) standard can demonstrate how serious a company is about attracting and retaining good employees.

That doesn’t mean you should quit or turn down a job if it doesn’t offer a great 401(k). But knowing how to spot a top-notch retirement plan can help you evaluate job opportunities, negotiate a salary increase to make up for what you lack and perhaps encourage your employer to improve their plan.

Here are three characteristics of great 401(k)s.

A good 401(k) comes with a company match, lots of cheap investment options and low fees. A great 401(k) won’t keep you waiting to take advantage of these features.

Many plans now allow participants to start paying dues immediately, with no waiting time. Others have waiting times of one to six months. Some require people to wait a full year — the maximum allowable under federal law — and that delay can be costly for workers.

Let’s say you’re 25 years old, earn $50,000 a year and can contribute 10% of your salary. The $5,000 you can’t save in year one, plus the typical $1,500 you wouldn’t make, could mean about $106,000 less in your retirement account by age 65 if you count from an average annual return of 7%.

If you change jobs in the future — which you almost certainly will — any waiting you experience could compound the damage.

Plans offer a range of different matching formulas, with some of the most common being 50% of the first 6% of salary and 100% of the first 3% to 6% of salary.

The more generous the match, the better for the participants – up to a point. Many plans have long vesting periods on employer contributions. You may not be eligible for matching funds until, say, you have worked for the company for three years. After you reach the three year mark, you would own 100% of all matches you earned and 100% of all future matches.

Another common approach is a six-year “staggered” vesting schedule. You may have to work two years before you get 20% of the game. You would receive an additional 20% after each year of service until after the sixth year you were 100% invested in past and future games.

However, long blackout periods have come under criticism for their negative impact on today’s more mobile workers. A 2016 report by the US Government Accountability Office found that if a worker in their 20s and 40s gave up two jobs before the transfer, the matches they forfeited could be worth $81,743 upon retirement.

A growing number of plans are giving employees immediate ownership of matching funds — 44.2% in 2021, up from 38.5% in 2017, according to Hattie Greenan, director of research and communications at the Plan Sponsor Council of America.

You’re always 100% invested in your own contributions, but it’s important to understand any restrictions placed on your employer’s contributions – and perhaps to push for shorter vesting periods.

Most plans today offer a Roth 401 (k) Option that allows participants to invest funds that will not be taxed upon retirement.

Contributions to a regular pre-tax 401(k) give you a pre-tax benefit, but withdrawals are taxed as income. Contributions to a Roth 401(k) don’t reduce your current tax bill, but retirement withdrawals are tax-free. Financial planners often suggest clients have money in both pre-tax and tax-free accounts to better manage their tax bills in retirement.

The IRS limits pre-tax and Roth 401(k) contributions to $20,500 in 2022 for those under age 50 and $27,000 for those age 50 and older. However, total contributions — from participants and their employers — can be as high as $61,000 for those under 50 or $67,500 for those over 50, if the plan allows.

Some plans offer the option to make additional after-tax contributions, which can help you put a lot more money into your retirement plan.

Say you’re under 50 and you’re maximizing your pre-tax contributions. Your company is contributing $6,000 for a total of $26,500. If your plan allows, you can contribute up to $34,500 to the after-tax option to meet combined employer and participant contribution compensation.

Money in after-tax accounts can grow tax-deferred, which is a nice perk, but some plans offer something even better: “in plan” conversions that let you quickly move the money into Roth accounts and minimize the potential tax bill. This combination of post-tax contributions followed by conversions is referred to as “Mega Backdoor Roth‘, and it can be super helpful for accumulating future tax-free funds.