Employees and employers alike are often at odds about the best type of retirement plans. Different budgets have different needs and some employee benefit packages offer more perks than others.
Typically, employers offer one of the many 401 retirement accounts— most popular in this category is offering a 401k.
However, employees tend to be skeptical if the company 401k is the best choice for their investment needs. This is especially true when looking at similar alternatives, such as IRA accounts and “Roth” designations.
Educating your employees on the differences between these options is part of your responsibility as a plan sponsor. It’s one you must take seriously as for many, these investment accounts make up the entirety of their retirement savings, meaning they not only take a large amount of an employee’s current earned income, but they build the foundation to their retirement plan later on.
If you need a quick guide on the major differences between 401k and IRA plans, keep reading for a quick refresher.
When discussing plan contribution limits with your employees, it is important to point out the rather extreme differences between those offered by a 401k in comparison to IRA contributions.
As of 2020, annual contribution caps are as follows:
|Plan Participants Under 50||Plan Participants Over 50|
|401k||$19,500 annually||$26,000 annually|
|IRA||$6,000 annually||$7,000 annually|
One of the main reasons for this large discrepancy is the relative rigidity or flexibility of each plan type.
While 401ks can offer matched rates and offer a tax deductible on income taxes, these plans are plagued with early withdrawal fees until retirement age. While there are fever perks with an IRA account by way of contribution matching, so long as an employee holds one such account for 2 years, they are no longer subject to withdrawal fees and have greater flexibility overall.
Directly related to annual maximums are matching contributions. Note that while employees are not required to match any, or all, of their employee contributions, not offering a match greatly reduces the allure of a 401k. This is particularly true for individuals who may not otherwise have the financial stability to invest a larger percentage of their income.
However, matching is not seen in IRA accounts as they are not employer sponsored.
While this does not make IRAs worthless, it does change their strategic implication for most employees— the IRA being treated as a secondary personal account to be used only after 401k limits are reached.
As such, it is recommended that employees meet your full 401k match amount before contributing into a secondary, personal, IRA.
Sometimes it is not clear to employees that retirement accounts such as 401k plans do not necessarily work as a savings account. Because of the various tax benefits, deferred payments, and matched contributions, 401k plans have strings attached.
Employers must be made aware of these, most importantly:
- Income tax must be paid on any amount withdrawn from a traditional 401k
- Early withdrawal fees apply to any individual looking to take disbursements before the age of 59 and ⅓
- Even if an employee does not withdraw early, they will be forced to take disbursements no later than age 72
As mentioned previously, IRA accounts are free from many of these strings as they exchange benefits for financial freedom. For employees planning large financial expenses in the future or who are worried about not having access to penalty-free withdrawal should the need arise, a 401k plan may not be the safest investment decision.
Investment Control and Diversity
When you sponsor a 401k plan, there are many fiduciary responsibilities you assume. The reason for these added expectations is that plan holders have very little say in the types of investments contained in their plan. Instead, they are at the mercy of plan administrators, investors, bookkeepers, and sponsors, to ensure their best interests are at heart.
Generally, a plan sponsor is responsible for making sure there are knowledgeable financial advisors handling their retirement accounts. This includes ensuring they are not price-gouging through hidden fees in addition to checking in on portfolio performance over time.
Another layer of responsibility rests in the plan sponsor being the liaison between financial advisors and their employees. Because of the low level of contact and control employees have over their investments, it is up to plan sponsors to keep them updated and educated on the various happenings in their account. This includes changes to the plan structure, changes in investment diversity, and any new laws that would potentially impact their investments.
While this sounds like a great deal of effort, much of these responsibilities can be met through 401k benchmarking— a service in which a third party company takes an analysis of your offered 401k plans, their performance, and where they might need improvement.
When looking at the tax-deferred status of 401 k accounts, plan sponsors must think long and hard about the overall implication these accounts will have for their employees.
For instance, by offering a 401k plan, you might also offer strategic tax benefits through plan deductions.
As mentioned previously, 401k contributions are tax-deductible, meaning that an employee who is on the upper end of a tax bracket might be able to avoid paying higher income taxes through meeting a certain contribution amount.
Finally, the tax status of the offered account is directly related to its tax exemption status. This mandates forced disbursements after a certain age, as mentioned previously.
In the case of 401k plans that use pre-tax dollars, there is a forced withdrawal beginning at the age of 72. At this point, the individual needs to pay income taxes on all withdrawn funds. The same is true for Traditional IRAs.
The exception to this rule, logically, is the Roth IRA and Roth 401k. Since Roth accounts are built on contributions of post-tax dollars, there is no reason to pay taxes a second time upon withdrawal. For Roth IRAs specifically, this feature also allows plan holders to withdraw funds at any time before retirement age without incurring early withdrawal fees.
Unfortunately, by using a Roth account, the overall investments, and gains, will be a smaller dollar amount— creating a complicated game of push and pull for many employees.
Benchmarking Helps Employers Support Employees
Whether your company is new to offering ERISA-qualified plans or you are looking to ensure you are in compliance with ERISA law, benchmarking 401(k) portfolios are an important part of the process.
Under ERISA, improperly managed portfolios can cause a great deal of liability for financial advisors and companies alike. Employees have a right to know how their portfolios are being managed, what fees are being withdrawn, and whether or not their plan rates and performance is reasonable.
We know how important this is, so at Benchmark My Plan, we decided to offer the service to investors at no charge to them.
Our large network of financial advisors are ready to help you benchmark your 401(k) at a moment’s notice. Reaching out to us is quick and easy. Simply give us a message or call and we can connect you with an advisor that is right for your case.
Are you ready to protect your investments? Benchmark today.