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 year to begin contributing, etc.

Of course the interesting thing through all these conversation is I often learn something new. Retirement plan laws can be very complex and no two employer 401(k) plans will generally be alike. I am still learning about some of the pitfalls of some 401(k) plans myself. Below I share a few good things to know about how different 401(k) plans can bet set up. When interviewing for potential jobs also keep in mind that no two plans are alike. Understanding more about these plans and asking the right questions can help you make sure you find a 401(k) plan that works for you. Below are five things you should know about your own, or any potential employers’, 401(k) plan.

1. Waiting Periods

As with many benefits, employers generally have waiting periods before you can begin to participate in a 401(k) plan. On average, most employers make you wait one year before you begin to participate in a 401(k) plan. However, I do hear it is more common these days to have a shorter waiting period. On the other hand, as with many of these rules, do not get too upset at the employer for choosing the waiting period if you are unhappy with it. I had a client who wanted to decrease the waiting period for their employees (in order to recruit an employee who balked at the long wait). The best they could do was change it from 12 months to 9 months due to the way the plan was set up, and the rules of ERISA (Employee Retirement Income Security Act).

The retirement administrators keeps on top of all the ins-and-outs of ERISA and it is really Greek to me as it just can get so complex. Just know there are many rules how plans can be set up, and once set up many rules are nearly impossible to change — one reason being to be fair to other employees (in this case the other employees who had to wait one year). There are a lot of rules with ERISA meant to keep favoritism to certain employees out of 401(k) plans.
This is good to keep in mind when looking for a job. Given 2 exact job opportunities, the one with a shorter waiting period into the 401(k) plan will be to your benefit.

Also, keep in mind that some of these 401(k) plans are set up so that you can only enter the plan on certain dates of the year. If you begin a job on January 3, and the only entrance date is January 1, technically you would have to wait another 6 months.

Most plans let you enroll multiple times throughout the year, but this is something to keep an eye out for, so you don’t falsely believe that you have to wait 6 months. In an example like I mentioned, if you notice you are close to, but after, an enrollment date, ask if you can get your employment start date officially changed so you can start in the plan sooner. Some employers will oblige.

2. Vesting

Vesting is also something very important to keep in mind when comparing more than one 401(k) plan. Vesting refers to how much money you get to keep from a particular retirement plan. If you put money into a 401(k) plan you get to keep 100% of your contribution, and any earnings that your investment makes. It is your money. However, vesting will refer to the employer match.

For example, an employer match that vests over 5 years will generally vest 20% every year. What this means is if they contribute any money to your account (match) during the first year and you left your job before the year was over, you would be 0% vested. You would not get to keep their matching contribution. If you stayed on one full year you would then be vested 20% and would able to keep only 20% of the match that your employer had given you. The following year you would vest to 40% which means you would get to keep 40% of all the monies they had matched you over the years, and so on. Vesting schedules are all set up differently as well, but the most common vesting schedule is 100% over 5 years, or 20% per year.

It is important to know this when evaluating 401(k) plans. Say employer #1 has a 3% employer contribution but vests over 3 years. Employer #2 has a 10% match but vests over 6 years. Employer #2 sounds like it has a really nice match, which would be a great addition to your retirement. However, you would have to work for that employer for 6 years to see the full benefit. In this case, if you left after 3 years, neither employer is offering much more than the other. Likewise, if you don’t expect to be at a job very long, there may be no reason to even worry about the 401(k) plan. You may never be able to contribute, much less see a dime of employer match.

3. Automatic Enrollment

Historically, if you decide to participate in your employer’s 401(k) plan you have to decide how much of your paycheck to contribute and you also have to choose what mutual funds or other investments that you want to contribute to. Indecision is a big factor for putting off the decision to participate. New laws, however, are making it easier for employers to set up automatic enrollment for their 401(k) plans.

What this means is as soon as their employees meet the requirements to participate in the plan, the employer automatically begins to withhold a set percentage from their employee’s checks and the employer can also choose the funds for these investments. Your employer can also increase your contribution percentage by one percent every year.

This is good news for the lazy savers out there, or the procrastinators who never got around to filling out all the paperwork. However, employers must disclose their automatic enrollment plan and give you an option to opt out. So don’t worry, this is not anything that can be done against your will. However, I point it out as something that is becoming more common when it comes to 401(k) plans. Don’t use this as an excuse to sit back and be lazy. Evaluate your investment choices and see if you can contribute more than the token 3% of pay that your employer is going to start you with.

4. Read the Fine Print on 401(k) Matches

Not all employer matches to 401(k) plans are good matches. Of course they have to word these things in an extremely complicated manner and make it difficult to understand, maybe in the hopes to make the match appear better than it really is. Often 401(k) matches are worded as to not be entirely clear. They will usually contribute x% of the first y% of money that you contribute to your 401(k). Confused?

Sometimes employers will contribute a certain percentage of your pay as a match, but usually it will be a percentage of your 401(k) contribution, worded confusingly as stated above. Here is a good example when it comes to the complexities of 401(k) plans. I usually advise that people who want to contribute the maximum to their 401(k), which according to federal tax law is the lesser of $15,500, in 2007, or 100% of your compensation, to contribute as much on as early as possible. The reason being that if you leave your job (by choice or by unexpected layoff) that you will be able to make the max for the year since by starting a new job you may need to wait a while before you can participate in the 401(k) plan.

I recently learned that this is not exactly the best advice in that some employers structure their match so that they only contribute a certain amount of each of your paycheck. The wording would be something like the first 6% of each paycheck that is contributed to a 401(k) plan will receive a match of 50%. In this case, if you contribute to your 401(k) plan only a few months out of the year, the odds are you will lose out on some significant employer matching. So read the fine print in your 401(k) plan and structure your contributions accordingly.

5. Employer Can Impose Limits to your Contributions

Another thing to watch for is employer limits on your 401(k) contributions. You may be excited to get a big raise and might be ready to attempt to max out your 401(k) for the year (again the maximum is the lesser of $15,500 or 100% of your compensation, in 2007). However, you may just find out that your employer will not let you put away so much. Worse, they may have no cap on your contributions, but they could come back at the end of the year and say you have to take back some of your contribution. What is going on?

Well, for one, employers can set limits on how much their employees can contribute to the 401(k) plan. Every plan is different, every employer is different. So this is definitely something you need to ask about when comparing potential employers. However, most of the time that you will come across this limit is if you are a “highly compensated employee” as determined by ERISA.

By law (a very complicated law at that) employers can not have highly compensated employees (generally those who make six figures or more) participate in and contribute to their 401(k) plans at a rate much higher than other employees. The rules are extremely complex and hard to figure out, so generally employers set a cap on what their employees can contribute, to avoid problems. The last thing they want is for the entire retirement plan to be disallowed because they did not follow all of the rules.

Employers will tend to be conservative in this case and set a lower contribution limit for its employees. The fact is how much one can contribute will not really be known until the “nondiscrimination” rules are tested, most likely after year-end. This is why in some cases some employers can never have a problem, and then suddenly find themselves afoul of the nondiscrimination rules, and they may find some employees have contributed more than allowed. This is rare, but it does happen. This is why most employers will err on the side of caution, as well as to simplify the whole process.

The bright side in this is that the new automatic enrollment procedures have so far meant better participation in 401(k) plans. A lot of the key in avoiding this higher compensation conundrum is getting more lower-wage employees to participate in the 401(k) plan.

Some employers also set up “safe harbor plans” where they agree to match a flat 3% of every employee’s salary to the plan, whether they participate or not. In this case the discrimination rules do not have to be followed and the top earners can contribute the max (while no one else has to). The interesting thing is that these safe harbor plans are quite common for small employers, so the business owners can max out their retirement, by giving a token match amount to their few employees. They can also skirt a lot of the costs of compliance by getting around the more complicated maintenance of most 401(k) plans. Just an interesting tidbit that small employers can offer really good retirement benefits for this reason. For any company where management is eager to contribute the max to their retirement plan you will be more likely to see a plan like this.

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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.


  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:


    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:

    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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