Benefits of a 401(k) Plan You Haven’t Considered | Retirement

However, there are also lesser-known perks of 401(k) plans that may appeal to employers as well as employees. These include different tax benefits, new ways to tap into fund balances and easier options to save for retirement.

“There’s been a ton of legislation that’s morphing what the 401(k) can do,” says Nate Moody, a retirement plan advisor with Lebel & Harriman Retirement Advisors in the Portland, Maine, metro area.

Here are nine 401(k) advantages you may have overlooked:

Depending on the plans offered by their employer, workers may be able to choose whether to pay taxes on their retirement funds now or later.

Contributions of up to $22,500 to traditional 401(k) accounts are tax-deductible in 2023. Workers age 50 and older can benefit from catch-up contributions for a total of $30,000 in tax-deductible contributions this year. Money grows tax-deferred and then is subject to regular income tax when withdrawn in retirement. At age 73, retirees must begin taking required minimum distributions, also known as RMDs, regardless of whether they need the money.

However, many employers also offer a Roth 401(k) option. This newer version of the 401(k) plan doesn’t offer deductions for contributions. After-tax money is deposited into the account, and withdrawals in retirement are tax-free. There are no RMDs with a Roth 401(k).

Both accounts come with 401(k) tax benefits, and which one you choose will depend on your personal circumstances. People should ask themselves, “Am I going to be in a better tax bracket when I retire?” advises Andrew Meadows, senior vice president of HR, brand and culture at Ubiquity Retirement + Savings, a firm that provides 401(k) accounts to small businesses.

For younger workers who have mortgage and child deductions now and may have significant gains in their investments over the years to come, it may make sense to forego an immediate tax deduction in favor of a Roth 401(k) that could result in substantial tax savings later.

In addition to making tax-deductible and Roth contributions to a 401(k), workers have the option of making what are known as after-tax contributions. This ability opens up some other savings possibilities.

The first is a strategy known as a mega backdoor Roth. In 2023, the government allows up to $66,000 in combined employee and employer contributions to a 401(k) for younger workers and $73,500 for those age 50 and older. Those with annual incomes less than these amounts are limited to contributions equal to 100% of their compensation.

Assuming someone has maxed out their tax-advantaged contributions, they could make up to $43,500 in after-tax contributions to a 401(k) depending on if and how much their employer matches. Assuming it is allowed by the employer, this after-tax money can then be transferred to a Roth IRA so that future gains can be withdrawn tax-free.

“We don’t see it that often,” says Taylor Hammons, head of retirement plans for Kestra Financial in Austin, Texas, noting that not all 401(k) plans allow after-tax contributions.

What’s more, there’s only a small percentage of workers who have the financial means to make contributions of that size. That means the mega backdoor Roth strategy isn’t going to benefit most workers, but it’s a valuable tool for those who are able to use it.

In addition to offering different options for the tax treatment of contributions, 401(k) plans have expanded how employees can manage their money.

“Back when 401(k) plans came out in the 1980s, there was no help,” Hammons says. “You had to do it yourself.”

Today, many 401(k) plans offer workers access to professional assistance that may include personal consultations with financial planners. Plus, target-date funds are considered a standard feature in many accounts. These funds place worker savings in investments deemed appropriate for their expected retirement date. Risk-based funds are also an option in some plans, and these too can take some of the mystery out of selecting investments.

More recent innovations include the option to open brokerage accounts within 401(k) plans, according to Meadows. This opens the door for workers to actively trade various securities within their retirement account, but these can come with higher fees and greater risk.

Managed accounts are another increasingly popular option. “This has caught a lot of traction in the last six to nine months,” Hammons says. These accounts allow workers to enter personalized information about their family situation and retirement goals to receive customized portfolio suggestions.

All 401(k) plans must comply with the Employee Retirement Income Security Act, commonly called ERISA. As a result, employers have a fiduciary responsibility to create a plan based on their employees’ best interests.

“Employers are held to an incredibly high standard for how they manage (retirement) money,” Moody says.

Plan administrators can’t push investments that maximize profits. Instead, they need to ensure workers have access to stable funds with reasonable fees. They also must disclose information such as administrative expenses and historical fund performance to help employees make informed investment decisions.

Another benefit of ERISA is that it protects assets from creditors. In the event a judgment is entered against a worker, assets held in qualified funds such as 401(k) accounts cannot be garnished. However, this protection does not extend to certain government garnishments such as those for federal income taxes or criminal fines.

The convenience of 401(k) plans is an often overlooked benefit. Not only do payroll deductions make it simple to fund retirement savings, but many companies have also set up automatic contributions for new hires.

“They can almost put it on cruise control,” Hammons says. Currently, plans not only can automatically enroll workers, but they can also automatically increase their contributions each year unless an employee opts out.

While some companies may be hesitant to implement these options for fear of appearing “paternalistic,” according to Moody, automatic enrollment can be a boon to the balances in worker accounts.

In 2022, those who were auto-enrolled in their retirement plan saved 40% more, according to the How America Saves 2023 report from Vanguard. What’s more, plans with automatic enrollment saw 93% of workers participate compared to 70% of workers with plans that have voluntary enrollments.

Beginning in 2024, all new defined contribution plans – including 401(k) accounts – will be required to automatically enroll new hires as a result of the SECURE 2.0 Act.

Normally, withdrawing money from a 401(k) account prior to age 59 1/2 results in a 10% tax penalty. However, these plans have provisions that can turn them into a safety net during difficult financial times.

Money from a 401(k) may be accessed through hardship withdrawals for reasons such as medical care, college tuition and funeral expenses. “Not every 401(k) plan will have this,” Meadows says.

Those that don’t allow for hardship withdrawals may have provisions for loans, although these too are dependent on your plan’s rules. Typically, loans are capped at 50% of the vested balance, up to $50,000 total. Loan payments can then be paid back using convenient payroll deductions.

However, if you leave your job, be aware that any outstanding balance must be paid back by the next tax filing deadline. Otherwise, the loan may become taxable and subject to the 10% penalty.

Taking a loan or an early distribution from a 401(k) account can have a negative impact on your long-term savings, so be smart about using this financial tool. Generally, this is an option to be reserved as a last resort, and money should not be pulled out for discretionary purchases such as a vacation.

Early retirees are allowed to pull money from their account before age 59 1/2 as well. That means someone who leaves an employer at or after age 55 can take withdrawals for any reason without penalty. Known as the rule of 55, there are some restrictions. For instance, you can only withdraw money early from the 401(k) plan of the employer you just left, not from other retirement funds.

The SECURE 2.0 Act creates new ways for employees to be able to access their funds in the event of an emergency beyond the current hardship withdrawal and loan provisions.

Beginning in 2024, employers may allow workers to take a $1,000 emergency savings withdrawal each year. This money isn’t subject to an early withdrawal penalty and doesn’t come with the same restrictions as other hardship withdrawals. It must be paid back within three years.

Another new option is the creation of emergency savings accounts within 401(k) plans. These accounts can be funded up to $2,500 per year and may be eligible for an employer match. Contributions will come from after-tax dollars, and workers can access money at any time.

“We’re seeing employees increasingly looking to their employers for financial assistance,” Moody says. While employers won’t be required to offer emergency savings accounts, doing so is one way for companies to meet the needs of their workers.

Another provision of the SECURE 2.0 Act – and one that Moody predicts will be popular – is the option for employers to make matching contributions to a 401(k) account based on a worker’s student loan payments.

While a similar program has been offered by Abbott Laboratories to its employees since 2018, the recent legislation expands the option nationwide. Beginning in 2024, employers can match their workers’ student loan payments up to a maximum of 5% of their annual compensation. This match can be offered even if a worker is not contributing to the 401(k) plan themselves.

With nearly 44 million people estimated to have federal student loan debt, matching loan payments with contributions to 401(k) accounts could have broad appeal. It can also serve as a way for workers to address two financial needs – paying off debt and saving for retirement – at the same time.

While workplace retirement plans have clear benefits for employees, business owners may be wondering: Are 401(k)s worth it? The answer, according to experts, is yes.

“(Employers) know the benefit,” says Hammons. Having a robust retirement plan can attract quality job candidates and keep key employees from leaving for other positions. “They know it makes it competitive.”

Thanks to government tax credits, starting a 401(k) plan for employees isn’t necessarily expensive. “If this plan is brand new, you can actually get tax credits for the first three years,” Meadows says. Those credits may be enough to almost fully cover the cost of administering the plan.

A 401(k) plan comes with valuable tax benefits for employees as well as employers, but that isn’t the only reason to love these accounts. They can also give you the tools to make smart investment decisions, build emergency savings and more.