You probably think of your 401(k) as your retirement account -- and you'd be right, to a degree. You decide how much you'd like to defer from each paycheck and these funds are always yours to use as you'd like.
But at the end of the day, a 401(k) is an employer-sponsored retirement plan, and your employer gets a lot of say in how the plan operates. Here are five surprising ways your company can control your 401(k), for better or worse.
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1. Who can contribute
Employers may allow new hires to begin participating in the company's 401(k) plan right away, but they don't have to. Federal law only requires employers to allow employees to participate if the employee is at least 21 years old and has at least one year of service with the company.
If you fail to meet one or both of these criteria, you may have to wait to join the 401(k) plan. You'll have to use an IRA, a health savings account (HSA), or a taxable brokerage account in the meantime if you still want to invest.
2. What investment options you have
Most 401(k)s don't permit you to invest in whatever you like. You usually choose from a handful of mutual funds, and your employer is in charge of selecting the options. This isn't always a bad thing. If you don't know a lot about investing, you might welcome having a smaller list of choices to pick from.
It can be frustrating, though, if you don't like the options your employer selects. In that case, you could try talking to your employer about adding new investment choices. Or you might prefer to put just enough in your 401(k) to claim your company match, if any, and then switch your contributions to a different retirement account.
3. How your 401(k) match works
Companies aren't required to offer 401(k) matches, though many do to attract good talent. Each company sets its own matching formula. Usually, you get $1 or $0.50 for every $1 you put into your 401(k), up to a certain percentage of your income.
Most 401(k)s also have some sort of vesting schedule. This determines when you're able to keep your employer-matched funds if you leave the job. A few companies may allow immediate vesting while others use either a cliff or graded vesting schedule.
Cliff vesting schedules require you to work for a company for a certain number of years and then you become vested all at once. Quitting before you've worked long enough will cost you all of your employer-matched funds. Graded vesting schedules release your funds to you gradually over time. For example, you may be able to keep 25% of your employer-matched funds after one year, 50% after two years, and so on.
If you have any questions about how your 401(k) match or vesting schedule works, talk with your HR department. Use this information to guide where you'd like to keep your retirement savings.
4. Whether you can take loans
Some 401(k) plans permit you to take loans from your account, up to the lesser of 50% of your vested balance or $50,000. This is more appealing than a traditional loan to some because you pay back what you've borrowed with interest to yourself over time. But if you fail to pay back what you owe in a timely fashion, the IRS considers it a distribution and taxes you accordingly. You could also owe a 10% early withdrawal penalty if you're under 59 1/2 years old.
Not all 401(k) plans allow loans. Your employer has the final say here. If you're interested in getting a 401(k) loan, talk to your HR department to learn whether this is an option for you. Just remember, taking out a loan will likely hurt the growth of your retirement savings, even if you pay it back over time.
5. What happens to small 401(k) balances after employees leave the company
Federal law prohibits employers from touching 401(k)s with balances of $7,000 or more. If former employees want to leave these accounts alone, they can do so for as long as they like. But the same can't be said for those with smaller balances.
Employers have the right to transfer 401(k) balances between $1,000 and $7,000 to an IRA in your name. If your company does this, it will notify you of the move and explain how you can access your funds. But there isn't anything you can do to stop this transfer from going ahead. That's why many people prefer to transfer their old 401(k)s elsewhere before their employers can.
If you have less than $1,000 in your 401(k), it's even more important that you take action soon after leaving the job. Employers can legally cash out your 401(k) in this situation. They'll send the money to you, withholding 20% for taxes. But you must deposit the full 401(k) balance in a new retirement account within 60 days or the IRS considers it a distribution. That means you'll need extra cash on hand to pull this off. If you do, you'll get the 20% your employer withheld back when you file your tax return.
It's much simpler to move your money before your employer has a chance to using a direct rollover. This is where you tell your 401(k) provider where you'd like the funds sent and it handles the transfer for you.
These rules may not all be relevant to you right now, but they're worth keeping in mind anyway. Understanding your 401(k) plan's features and limitations is key to getting the most out of it. And if you have any questions about your account, don't hesitate to reach out to your employer for clarification.
