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| 401(k) Plans:
Match, Point, and Set |
| Named for a section of the Internal Revenue Code, 401(k)s may not have the catchiest name, but they have definitely caught on since their introduction in the 1970s. With many popular features, 401(k)s are the most common defined contribution plan in the U.S. today and have almost made pensions obsolete. |
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| Employees have embraced these plans, in part, because they can make contributions on a pretax basis (before taxes are deducted from paychecks). For employees in the 28% tax bracket, a pretax contribution of $100 translates to a mere $72 reduction in pay.(If your employer offers the new Roth 401(k) option, however, those contributions are post-tax; you get the benefit of withdrawing your earnings tax-free when you retire.) |
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The level you can contribute to a 401(k) ranges anywhere from 0% to 100% of salary, but a yearly dollar cap applies ($ for ). Employers often encourage participation by contributing money (a match) to the accounts based on an employee's contribution level. For example, an employer might match 50% of the first 5% of salary an employee contributes. Most financial professionals will recommend that you contribute at least up to the company match. Employer contributions are not taxed as salary, but are taxable when you withdraw them at retirement. These matches aren’t guaranteed—employers can reduce, suspend, or eliminate a match at any time.
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When companies offer to match your 401(k) contributions, "highly compensated employees" (generally, those with annual salaries of more than $) need to do some calculations on how much to save each paycheck. If they set their contribution rate too high, they could reach the maximum before the year is up. When they don't contribute, the employer's match is zero, forcing the employee to miss out on free money. If you're fortunate enough to have this dilemma, you should calculate a deferral percentage that leaves you just under the cap by year's end.
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