Weston: How to spot a great 401(k)

Many plans now allow participants to begin contributions immediately, with no waiting period. Others have waiting periods of one to six months. Some require people to wait a full year — the maximum allowed under federal law — and that delay can be expensive for workers.

Let’s say you’re 25, earning $50,000 a year and able to contribute 10% of your pay. The $5,000 you can’t contribute the first year, plus a typical $1,500 match you wouldn’t earn, could mean about $106,000 less in your retirement account by the time you’re 65, assuming 7% average annual returns.

If you change jobs in the future – as you almost certainly will – every waiting period you encounter could compound the damage.

A GREAT 401(K) LETS YOU KEEP THE MATCH

Plans offer a number of different matching formulas , with some of the most common being 50% of the first 6% of earnings and 100% of the first 3% to 6% of pay.

The more generous the match, the better for participants — to a point. Many plans have long vesting periods for employer contributions. You might not have a right to any matching funds until you’ve worked for the company for three years, for example. After you hit the three-year mark, you would own 100% of any match you’ve earned and 100% of any future matches.

Another common approach is a six-year “graded” vesting schedule. You might have to work two years before you get 20% of the match. You would get another 20% after each year of service until you were 100% invested in past and future matches after year six.

But long vesting periods have come under fire because of their negative impact on today’s more mobile workers . A 2016 report by the U.S. Government Accountability Office found if a worker left two jobs before vesting, at ages 20 and 40, the matches they forfeit could be worth $81,743 at retirement.

A growing number of plans give employees immediate ownership of matching funds — 44.2% in 2021, up from 38.5% in 2017, according to Hattie Greenan, director of research and communications for the Plan Sponsor Council of America.

You’re always 100% vested in your own contributions, but it’s important to understand any restrictions imposed on your employer’s contributions — and perhaps push for shorter vesting periods.

A GREAT 401(K) GIVES YOU MORE WAYS TO SAVE

Most plans today offer a Roth 401(k) option that allows participants to put away money that won’t be taxed in retirement.

Contributions to a regular, pre-tax 401(k) give you an upfront tax break, but withdrawals are taxed as income . Contributions to a Roth 401(k) don’t reduce your current tax bill, but withdrawals in retirement are tax-free. Financial planners often suggest clients have money in both pre-tax and tax-free accounts to better manage their tax bill in retirement.

The IRS limits pre-tax and Roth 401(k) contributions to $20,500 in 2022 for people under 50 and $27,000 for people 50 and older. But total contributions — by participants and their employers — can be up to $61,000 for people under 50 or $67,500 for those 50 and older, if the plan allows it.

Some plans offer the option to make additional, after-tax contributions, which can help you stuff a whole lot more money into your retirement plan.

Let’s say you’re under 50 and max out your pre-tax contributions. Your company contributes a $6,000 match, for a total of $26,500. If your plan allows, you could contribute as much as $34,500 to the after-tax option to meet the combined employer and participant contribution allowance.

Money in after-tax accounts can grow tax-deferred, which is a nice perk, but some plans offer something even better: “in plan” conversions that let you quickly move the money into Roth accounts, minimizing the potential tax bill. This combination of after-tax contributions followed by conversions is known as a “mega backdoor Roth ,” and it can be mega-helpful in piling up future tax-free funds.

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