For many Americans, 401(k) plans are a staple of retirement. Yet, not all such plans are created equal. Consider these factors to determine how yours stacks up. You owe it to yourself to learn the particulars.
Tax options
Taxes play a huge role in retirement planning. While some 401(k) plans accept pre-tax contributions that lower your taxable income today, others, like Roth 401(k)s or IRAs, invest after-tax dollars, allowing you to make tax-free withdrawals in retirement.
Which option is best for you depends on your age, risk tolerance, and investment objectives. What's important is that your 401(k) plan provides the flexibility to choose among a variety of options.
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Employer matching
It's tough to beat employer contributions for retirement savings, but some companies are more generous than others. For example, let's say Company A provides employees with a 50% match on their annual contributions up to a total match of $9,000, while Company B only matches contributions of up to 2% of employee salaries.
Let's assume your salary is $60,000 a year, you contribute the IRS maximum of $18,000 per year, and you earn a 7% annual return on your investments. The table below illustrates just how much employer matching can affect your bottom line.
| Company | Maximum Contribution + Company Match | Year 10 401(k) Balance | Year 20 401(k) Balance | Year 30 401(k) Balance |
|---|---|---|---|---|
| Company A | $27,000 | $399,000 | $1.2 million | $2.7 million |
| Company B | $19,200 | $284,000 | $842,000 | $1.9 million |
Table by author.
Employer contribution timing
The money you add to your 401(k) is vested immediately, but employer contributions are a little different. Suppose your company matches 6% of all contributions up to $18,000. While it may seem like you received $1,080 last year, your company might require you to remain employed for five years before being 100% vested, which means that you'll effectively only receive 20% per year, or $216, until the vesting period is complete.
If you leave the company before then, you'll likely forfeit the remaining funds. A short vesting schedule allows your money more time to grow, and fewer penalties for leaving your job.
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Management fees
The typical 401(k) plan is saddled with annual operating expenses. These are reflected in a fund's expense ratio -- annual expenses as a percent of invested assets.
A 2016 Investment Company Institute study found that the average expense ratio for equity mutual funds was 1.31%. Importantly, however, the average 401(k) plan participant paid only 0.53% for the same funds, as employers tend to offset half or more of the costs.
When reviewing your 401(k) options, it's a good idea to learn how much of the expenses your employer covers. If you're paying too large a share compared to the average, consider speaking with your fund advisor about how to reduce the costs, which might include choosing another option under your plan's umbrella.
Automatic options
Two-thirds of Americans aren't contributing to their 401(k) plans, according to the U.S. Census Bureau. That said, a 2016 Vanguard study found that plans with automatic enrollment had a 90% participation rate.
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If you struggle with budgeting, complacency, or a simple lack of understanding, a plan that manages your funds and automatically increases your annual pre-tax contributions could drastically change the course of your retirement.
Just because 401(k) plans are ubiquitous throughout corporate America, doesn't mean they're thoroughly understood by all participants. By familiarizing yourself with your investment options, you can make the most of your retirement funds.
Editor's note: A previous version of this article misrepresented Amazon.com's maximum 401(k) match. The Motley Fool regrets the error.
