Any 401(k) can help you save for retirement. A great 401(k) allows you to save a lot more.
The difference between a mediocre plan and an excellent one could translate into tens of thousands of dollars more in future retirement money. Additionally, the quality of a 401(k) can indicate how serious a company is about attracting and retaining good employees.
This doesn’t mean you should leave or turn down a job if it doesn’t offer a great 401(k). But knowing how to spot a best-in-class pension plan can help you evaluate job offers, negotiate a raise to make up for what you’re losing, and maybe encourage your employer to make their plan better.
Here are three characteristics of great 401(k)s.
A great 401(k) doesn’t make you wait to start saving
A good 401(k) comes with a company match, lots of low-cost investment options, and low fees. A great 401(k) doesn’t make you wait to take advantage of these features.
Many plans now allow participants to start contributing immediately, with no waiting period. Others have waiting periods of one to six months. Some require people to wait a full year — the maximum allowed by federal law — and that delay can be expensive for workers.
Let’s say you’re 25 years old, earn $50,000 a year, and can contribute 10% of your pay. The $5,000 you can’t contribute the first year, plus a $1,500 standard match you wouldn’t earn, could mean about $106,000 less in your retirement account by age 65, assuming 7% average annual returns.
If you change jobs in the future—as you almost certainly will—any waiting period you face could compound the damage.
A great 401(k) lets you keep the match
The programs offer a number of different types of matching, with some of the most common being 50% of the first 6% of earnings and 100% of the first 3% to 6% of pay.
The more generous the match, the better for the participants — up to a point. Many plans have long vesting periods for employer contributions. You may not be entitled to matching funds until you have worked at the company for three years, for example. Once you reach the three year mark, you will own 100% of any match you have won and 100% of all future matches.
Another common approach is a six-year “graded” vesting schedule. You may have to work two years before you get the 20% match. I would take another 20% after each year of service until you are 100% invested in past and future fights after the sixth year.
However, long vesting periods have come under fire for their negative impact on today’s more mobile workers. A 2016 report from the U.S. Government Accountability Office found that if a worker left two jobs before vesting, at ages 20 and 40, the games they miss could be worth $81,743 in retirement.
A growing number of plans give employees direct ownership of their funds — 44.2 percent in 2021, up from 38.5 percent in 2017, according to Hattie Greenan, director of research and communications for the Plan Sponsor Council of America.
You’re always 100% vested in your own contributions, but it’s important to understand any restrictions on your employer’s contributions — and maybe push for shorter vesting periods.
A great 401(k) gives you more ways to save
Most plans today offer a Roth 401(k) option that allows participants to set aside money that won’t be taxed in retirement.
Contributions to a regular, pre-tax 401(k) give you an upfront tax deduction, but withdrawals are taxed as income . Contributions to a Roth 401(k) don’t reduce your current tax bill, but withdrawals in retirement are tax-free. Financial planners often recommend that clients have money in both pre-tax and tax-free accounts to better manage their tax bill in retirement.
The IRS limits pre-tax and Roth 401(k) contributions to $20,500 in 2022 for people under 50 and $27,000 for people 50 and older. But total contributions — from participants and their employers — can be up to $61,000 for people under 50, or $67,500 for people 50 and older, if the plan allows it.
Some plans offer the option to make additional after-tax contributions, which can help you stuff a lot more money into your retirement plan.
Let’s say you’re under 50 and max out your pre-tax contributions. Your company contributes a $6,000 match, for a total of $26,500. If your plan allows it, you could contribute up to $34,500 in the after-tax option to cover the combined employer and participant contribution allowance.
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, minimizing the potential tax account. This combination of after-tax contributions followed by conversions is known as a “mega backdoor Roth” and can be very helpful in building up future tax-free funds.
This column was provided to The Associated Press by the personal finance website NerdWallet. The content is for educational and informational purposes and does not constitute investment advice. Liz Weston is a columnist at NerdWallet, a certified financial planner, and the author of “Your Credit Score.”