Not All 401(k) Plans Are The Same – Five Issues Everyone Should Know

401(k) retirement plan

I personally deal mostly with taxes in my professional capacity of an accountant. However, I have also come across a lot of the ins-and-outs when it comes to 401(k) plans as I used to audit 401(k) plans for large companies, and currently am involved in the setup, administration of, and accounting for 401(k) plans for many of my current small accounting clients. Whenever the subject of 401(k) plans comes up among friends, family, or professional or finance discussion groups, I always find it a good time to educate people on some of the ins and outs of 401(k)s. Most commonly, people come to me telling me it is not fair that their new employer limits contributions or that they have to wait a y

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16 Responses to Not All 401(k) Plans Are The Same – Five Issues Everyone Should Know

  1. How about the employer that holds the 401k match for a ridiculously long time? The official documentation for my plan says that the employer match will be deposited “sometime after the end of the year”.

    We’re 6 months into the year, and I haven’t seen it yet. That means some of the matching funds are from a year and a half ago. That’s a lot of time and growth that I miss out on.

  2. Teri says:

    Agreed, but this is also common. The employer match does not have to be deposited until September 15th of the following year. It’s kind of like an IRA where the employer has until the due date of the tax return, the following year. Most of my clients extend their tax return simply until they can scrape the money together for the match.

    But it is not always as simple as them waiting to shell out the money. 401(k) compliance is complicated and it takes time to calculate the match, etc. The amounts will depend on what everyone contributed for the year and is affected by many factors so waiting until after the end of the year is a function of accounting and a lot of red tape mostly, not necessarily your employer. Bigger companies with big resources are more likely to match throughout the year but honestly they are also more likely to take more fees out of your plan and more likely to have to fix mistakes later. IT is merely impossible to calculate the match as you go, with so many factors. Though honestly we usually know the match numbers pretty early in the year usually and our clients then wait until September to deposit the funds. My plan at my job is the same way – my 2006 match will not be applied for a few more months. Just the way it is.

  3. Annemarie Keehn says:

    This article was not only poorly written but incorrect as well. An example where someone has to wait 2 years to enter the 401(k) plan? (in that case, the plan has to have at least 2 entry dates per year)…
    Examples of 5 year cliff vesting schedule and a 10 year schedule in a 401(k) plan? These aren’t even legal…
    I think you need to do a better job of checking the credentials of the individuals who write these articles. This person was clearly not qualified to be writing on the topic of 401(k) plans…

  4. PensionGeek says:

    I agree that this article has MANY inaccuracies. While I applaud the author’s attempt to make 401(k) plan knowledge accessible to more people, they would be far better served with advice to read their Summary Plan Descriptions than hear such gems as step-up contributions being widely available (when they in fact are not, and employers are not exactly adopting even automatic enrollment in droves — because they have NOT meant better participation). The discussion of nondiscrimination testing was, unfortunately, almost nonsensical. The author displays no understanding of per-paycheck matching or the definition of highly-compensated employees. In short, I would urge anyone reading this article to immediately forget it. It’s not accurate, you will screw up your retirement planning (and possibly your relationship with your employer) because of it, and you will never actually learn how your plan works.

  5. Big Bish says:

    This guy is so terribly uninformed its disgraceful that he’s allowed to publish this drek. Hopefully someone will read these comments and navigate to a more helpful page that doesn’t have so many chicge references pulled from 6 o’clock news pieces designed to scare you about your 401(k) plan. If this guys trying to drum up business, anyone who hires him is getting what they deserve. Do some research pal!

  6. Joyce Coon says:

    I am a Qualified 401(k) Administrator and Qualified Pension Administrator (American Society of Pension Professionals and Actuaries designations) and read your article “Not All 401(k)Plans are the Same – Five Issues Everyone Should Know” with interest, being well aware of many common misunderstandings employees have with regard to retirement plans.

    Paragraph 3 under item 1 has a slight inaccuracy. If you begin a job on January 2 and the only entrance date is January 1 with a 1-year waiting period, you WILL be able to enter the plan on the January 1 next following your hire date. This concept can be confusing because we’re not used to dealing with fiscal years. Let me put it this way: If your date of hire is January 1, you will have completed a Year of Service on December 31. Therefore, if your date of hire is January 2, you will have completed a Year of Service on the following January 1. Most entry dates are written “on the x date coinciding with or next following completion of the eligibility requirements” so in your example of a January 2 hire date, the following January 1 would coincide with completion of 1 Year of Service. Also, IRS regulations do not allow a plan to make an employee wait more than 6 months after completion of 1 Year of Service (which is 1,000 Hours of Service in a 12 month period)to begin making deferrals unless the plan has an immediate vesting schedule.

    With regard to vesting under item 2, specifically paragraph 2: if a plan has a 5 year vesting schedule with 20% vesting each year, if you complete at least 1,000 Hours of Service in a plan year you will accrue a Year of Service for vesting purposes, even if you don’t work a full 12 months. So, if we go back to your entry example of a 1 year wait to get into the plan, a participant is already 20% vested when he is first eligible to participate! Unless a plan specifically excludes Years of SErvice prior to a certain age (typically 18) or prior to the plan effective date, hours of service count toward vesting from your date of hire. For example, say someone was hired 1/2/05, works full time every year, and the plan has a 1 Year of Service eligiblity requirement:

    1/2/05 Date of Hire
    1/1/06 Date of Participation (20% vested upon entry to the plan)
    12/31/06 40% vested
    12/31/07 60% vested
    12/31/08 80% vested
    12/31/09 100% vested

    One other comment about vesting – IRS regulations do not allow a 10 year vesting schedule on Defined Contribution plans – maximum is now 6 years @ 20% per year beginning with year 2.

    Finally, with regard to the last paragraph of the article – there are actually 2 types of safe harbor plans. The first is a 3% Safe Harbor in which everyone who is eligble to participate receives an employer safe harbor contribution equal to 3% of compensation, regardless of whether they defer to the plan or not; this is NOT a “match”. The other type of safe harbor plan is, indeed, a matching plan – safe harbor match. The most common safe harbor matching formulas are (1)100% on the first 3% deferred plus 50% on the next 2% deferred, or (2) 100% on the first 4% deferred. Because these contributions truly are matching contributions, only those who defer their own pay into the plan receive these contributions. Additionally, the safe harbor contribution, whether it is the 3% or the match, is 100% vested immediately, which is an attractive feature to participants.

  7. It’s been a really long time since I’ve read an article with so many factual errors. 10 year vesting? A safe harbor match of 3%? Is this author from the USA? The main point of the article, that 401(k) plans are not all the same, should be seen as a positive: employers have design flexibility, which will encourage more employers to set up plans and provide a higher level of benefits for employees.

  8. Ryan says:

    10 year vesting does still exist.. I work for the State Government and our retirement plan takes 10 years to get the employer contribution

    just FYI for all those saying that its illegal or doesnt exist anymore.

  9. PensionGeek says:

    I have no idea about governmental plans, such as mentioned by Ryan. Ryan, just so you know, governmental plans operate under vastly different rules than the 401(k) plans the writer discussed — which absoutely, positively do not allow more than a six-year graded schedule following passage of the Pension Protection Act last year.

  10. Teri says:

    Oh gosh I have been so busy I just saw this.

    Actually these are all things mostly I have seen, and I think I said in my first paragraph this stuff is greek to me. I try to shed some light on these things and I certainly appreciated the experienced people coming in to explain better/clarify, so thank you. 401(ks) are NOT my business I already said.

    “5 year cliff vesting schedule” – maybe I did not explain it well but I do not see anything illegal in my example – quite common. 10 years not legal – maybe – but I was just showing as an example to pay attention to the vest – thanks for the heads up.

    I understand per-paycheck matching fine but from my experience it leads to errors and fixes later (mostly small business not equipped to deal with it). As accountants we clean up the mess after year-end. You employer can match you each paycheck, but doesn’t mean there won’t be some corrections after year-end (there may well be).

    Reading your Summary Pan Description is excellent advice.

    Entrance dates – Joyce – this is why this is greek to me. So I should have said January 3? My point is this can be an issue – waiting 6 months longer than you expected. But certainly thanks for the clarifications!

    Safe Harbor – I know this is not technically a “match” – it is an employer contribution so was just trying to make it easy to understand for average joe blow. I apologize for the wrong use of term. I think to joe blow average money from a boss is a “match” though obviously it is not matching anything you contribute specifically. Sorry for the confusion though. I regret using the term.

    I’m not sure where the confusion with the 3% safe harbor match comes from, unless you just mean the use of terms. It is very common – I should have said 3% contribution. Thank you Joyce too for adding more on those.

  11. Teri says:

    One more comment – I think my vesting point was maybe not explained well. My point was that you earn the money gradually. I apologize for any confusion. It was not my attempt to describe a cliff vesting schedule. That is not what I meant. A cliff vesting schedule would mean you do not see a certain percentage until you have been in the plan for a specified period of time. My point was to say you vest a little each year. Sorry if that was not clear.

  12. Bob says:

    I am more confused, I am afraid, after reading this article and its comments than when I started researching!

    Would I be able to impose on one of you experts to explain the “one year maximum” waiting period? How does one find the relevant law?

    My employer has a 12 month waiting period, which I recently completed, only to find this concept of enrollment periods. I now have to wait an additional three months. It initially struck me as unfair — Lucy pulling the football away — but now I have been asked to research its permissibility.

    Any guidance much appreciated.

    Thanks.

  13. PensionGeek says:

    The longest you can be required to wait before making 401(k) deferrals is 18 months. It is common for employers to have a one year waiting period (eligibility) and a quarterly enrollment time (entry). I know there are some code sections that deal with this, but it should also be in the plan document as well. The eligibility and entry issues differ widely among plans, so they’re two of the many things I look up for every one of my clients, even if I’ve worked with them for years. The selection of entry dates has many functions in plan design, including determining who might be included in a nondiscrimination test, who might get a safe harbor contribution, who gets a match, etc. (There are always exceptions, however, so I may have to refer to many parts of the document to answer one or two questions.)

  14. Teri says:

    Yes-

    PensionGeek nailed it on the head. I work with mostly small employers and they usually only let you enroll every 6 months. So it indeed could be worse. Waiting an additional 3 months for an entry date is quite common and within the law.

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  16. Need advise says:

    Teri,
    My unions Annuity(401k) has a person wait an entire year of no employer contribuitions before I can transfer the money out of the unions annuity plan and into some investment or bank 401k plan of my liking. Is this legal? Why do I have to wait one full year? Thanks for your help..

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