Benefits of Different Types of 401(k) Plans

Many people think there’s only one option when it comes to 401(k) plans, but the reality is that these retirement savings accounts can come in a variety of flavors. While they all help you save money for retirement, each has its own unique set of benefits. In this article, we’ll explore the different types of 401(k) plans so you can better understand how to use them if they are available to you.

Traditional 401(k)

  • Contributions are made on a pre-tax basis. This means that you don’t pay any taxes up front. Even assets that grow in the plan grow tax-free. It is not until you collect on your 401(k) that you are taxed.
  • They require that employers do not discriminate between employees. All employees are given the same rates and opportunities when it comes to 401(k) plans.
  • Employer’s contributions can be forfeited if the employee leaves too early, depending on the company’s vesting schedule.
  • Employer and employee combined contributions cannot be larger than the annual limit of $57,000 in 2020 or 100% of the employee’s compensation, whichever is lower.

Roth 401(k)

  • Similar benefits as a Roth IRA.
  • Contributions are funded with after-tax dollars, meaning any contributions are made with money that has already been taxed.
  • No taxes are paid (income or capital gains) when you withdraw your contributions.
  • If your employer contributes as well, their contributions are considered “pre-tax” and are added to a separate account, which is treated as a traditional 401(k) for tax purposes.
  • The contribution limits are identical to those of a traditional 401(k) and are shared across all 401(k) accounts an individual has.

Solo 401(k)

  • Geared specifically for a business owner with no employees (with very few exceptions, explained below).
  • Because you are both the employee and employer, you can contribute up to 25% of your total compensation, for a possible maximum of $57,000 in 2020.
  • You’re also eligible for this account if a spouse works for you full-time.
  • Small business owners are also eligible with one part-time employee, provided the employee works less than 1,000 hours per year. 

Safe Harbor 401(k)

  • Designed to make sure lower paid employees aren’t being discriminated against.
  • Employer contributions are nonforfeitable and are fully vested, without delay.
  • Employer contribution cannot exceed 5% of the employee’s compensation.
  • Employers can either:
    • Match 100% of employee deferment contributions up to 3% of their annual compensation, and match 50% for each contribution that is over 3% but under 5% of the annual compensation.
    • Contribute 3% of each employee’s compensation regardless of any employee contribution.

Simple 401(k)

  • Intended for small business owners.
  • The business must have 100 or fewer employees.
  • Contributions are nonforfeitable as soon as they are contributed.
  • Employers must contribute to employee’s plans. They can choose to either:
    • Make a matching contribution of up to 3% of the employees’ wages, if they chose to defer.
    • Make a non-elective contribution of up to 2% of employee compensation regardless of employee contributions.

Self-Directed 401(k)

  • Same contribution limits and withdrawal rules as a traditional 401(k)
  • Lets you invest the money in your 401(k) as you see fit (with some restrictions). This can even include non-traditional and unconventional assets like real estate and cryptocurrency if your employer allows it.
  • You might have to pay more fees because of the investment types you can choose. It’s likely you’ll make more frequent trades, and trading fees can lower your overall rate of return.
  • It takes expertise to make it perform well. While there is the possibility for higher yields, there are also increased opportunities for higher risks, lower yields, and loss of principal.

How will you use your 401(k)?

Trying to decide how to best utilize your 401(k) plan can be difficult. Investment advisers, like those at Fisher Investments, can be a source of information and advice to help you understand markets, which can help you choose where to direct your 401(k) contributions.

For many Americans, investing in a 401(k) plan is a valuable tool to help achieve a successful and secure retirement. Don’t worry if you don’t fully grasp the details of all the different 401(k) options just yet. There are many resources, including the website of your 401(k) plan provider, available to help you make the best decision based on your options. Take full advantage of 401(k) offerings, and you’ll be one step closer to achieving your retirement goals.

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