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Wednesday, February 21, 2024

How to understand your 401(k) plan

Tips for understanding your 401(k) plan

Key takeaways 

A 401(k) retirement plan is a key part of your benefits package — but the type of plan each employer offers is slightly different. From an employer match to automatic increases to eligibility requirements, there are plenty of key questions to ask yourself. 

10.12.2021

A guide to evaluating an important part of your benefits package

If you’re among the millions of Americans who are changing jobs as part of the “great resignation,” you’ll likely find yourself evaluating 401(k) offerings. After all, a 401(k) retirement plan is a key part of your benefits package — but the type of 401(k) plan each employer offers is slightly different.

Here are some key questions you should ask when you’re examining a 401(k) plan.

What are the 401(k) plan’s investment options?

Your employer typically chooses the array of investment options that are available within your 401(k) plan. These options typically include the following types of investments, all of which are overseen by professional money managers:

  • Target date funds (TDFs): With a TDF, you’ll select a single fund that aligns with your expected retirement date. When retirement is far off, TDFs typically invest heavily in stocks to take advantage of their long-term growth potential. Over time, they gradually add more bonds to protect against losses as your retirement date approaches.
  • Target risk funds: With a target risk fund, you also pick a single fund — but the mix of underlying investments in the fund doesn’t change over time. Instead, the fund sticks to a strategy that matches the level of risk you’ve chosen. As investors approach retirement, they tend to switch from an aggressive target risk fund, which typically invests most or all of its assets in stocks, to a conservative target risk fund, which invests mostly in bonds.
  • Individual mutual funds: Many employers provide a short menu of mutual funds you can pick from. While each fund is typically professionally managed, you choose how much to invest in each one based on your own knowledge and preferences.
  • Managed accounts: With a managed account, you provide information about your financial circumstances and goals. Your retirement account is then professionally managed to align with your situation.

Some plans offer hybrids of the options above. For instance, at a certain age, one hybrid option could automatically transition your TDF assets to a managed account.

How much is the employer match?

Many employers include matching contributions as part of their benefits offering: If you contribute to your 401(k), they also contribute funds.

If your plan offers matching, many employers typically match 50% or 100% of your contributions up to a certain percentage of your salary. These contributions are often referred to as “free money” because you don’t have to do anything to earn them other than set money aside for your retirement. To make the most of this benefit, aim to contribute enough to your 401(k) to get the full employer match.

What are the plan’s automatic and default features?

To help employees save for retirement, many 401(k) plans use automatic features that get you started right away. Your plan might include:

  • Automatic enrollment: If your employer offers automatic enrollment, you’ll be signed up to contribute a percentage of your wages to the 401(k) plan. You can always change your contribution amount or even opt out of the plan altogether.
  • Default contribution rate: If you’re automatically enrolled, your employer will also set  the percentage of your wages that will be deposited in your 401(k) every pay period. The default rate is just a starting point — you can keep it the same or change it to a rate that works for you.
  • Default investment: Just as plans with automatic enrollment set a contribution rate for  you, they also automatically start you off with a specific investment option — often a target date fund. You can always switch to a different fund or funds if you like.
  • Auto escalation: With auto escalation, the percentage of salary you contribute to your 401(k) increases automatically each year — typically by one percentage point per year — until you reach a cap. So if you’re contributing 6% this year, your plan will automatically increase your contribution to 7% next year, and so on.

What are the eligibility requirements?

By law, you must be allowed to contribute to your 401(k) account after one year of service. However, many employers allow workers to begin contributing earlier. Be sure you understand your new employer’s rules so you can start saving for your future as soon as you are eligible.

The date in the name of the target date fund is the assumed date of retirement. The asset allocation becomes more conservative as the fund nears the target retirement date; however, the principal value of the fund is never guaranteed. 

Investing involves risk, including possible loss of principal.

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The Currency editors

Staff contributors

The CurrencyTM, a publication from Empower, covers the latest financial news and views shaping how we live, work, and play. We keep you current on ways to plan, save, and invest for life.

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