The mantle has definitely passed from the pension plan to the 401(k) plan as the standard of employee retirement plans. It had been a remarkable transformation from the traditional pension plan world since the 401(k) plan has only been in existence since the 1980s.
The 401(k) plan is part of a profit-sharing plan using mutual funds as the primary investment instrument in the plan. It has significant administration and record-keeping requirements and costs to meet federal labor (ERISA) and tax (IRS) law. The administrative costs are often passed to the employee in the form of higher mutual fund expenses inside the plan.
The employee primary participation in a 401(k) plan is the deferral of their compensation each pay period. The employer can elect to match the employee deferral or add a profit-sharing or non-elective contribution on behalf of each employee, all at their discretion and often subject to a vesting period. The maximum amount that can be contributed to the plan by the employer and employee is limited by tax law.
There are excellent income tax benefits to the employer and employee when an employee participates in the 401(k) plan through elective deferrals. Social Security tax cannot be avoided through employee contributions to a 401(k) plan, however.
Depending on the specific plan rules, a participant can borrow from their 401(k) plan under strict repayment terms. In addition, many 401(k) plans are adding a Roth (401) provision, which allows much higher contributions to a Roth account without the income and contribution ceilings of a traditional Roth IRA.
As retirement plan specialists, we help pre-retirees maximize their participation in a 401(k) plan and guide them to make the right funding and distribution decisions as part of their overall retirement plan.
