Types of 401k Plans: Which One Is Right for You?
If your employer offers a 401k plan, experts generally agree that you should be taking advantage of it and making contributions from each paycheck toward your retirement savings. However, not all employer-sponsored retirement plans are alike. Many employers offer what is considered a traditional 401k, but there are also safe harbor 401k plans, SIMPLE 401k plans, Roth 401k plans and 403b plans.
Keep reading to find out about which 401k plans might be available to you, the pros of cons and each, and how to determine if a 401k plan is the right choice for you and your retirement planning and saving goals.
Traditional 401k
A traditional 401k plan allows eligible employees to defer a fraction of their pre-tax pay to a retirement fund. Employers can contribute to these plans on behalf of all participants, make a matching contribution based on what the employee contributes or a combination of both. Employer contributions can be subject to a vesting schedule, meaning the employee only receives the full contribution after a set amount of time, or they can be immediately vested.
A traditional 401k plan can be provided by an employer of any size, and it can be combined with other retirement accounts such as a Roth IRA. Business owners who are self-employed can also open a solo 401k account. The traditional 401k contribution limit for a given year is $18,500 as of 2018.
Employers choosing to offer a traditional 401k to their employees are subject to annual tests — the Actual Deferral Percentage and Actual Contribution Percentage tests — to ensure that deferred wages and employer matching contributions do not discriminate in favor of highly compensated employees.
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Safe Harbor 401k
Many aspects of a safe harbor 401k are similar to a traditional 401k, but one difference is that employer contributions must be fully vested when made. Another difference is that an employer can make a contribution even if the employee opts out of making their own contributions. If your employer sponsors a safe harbor 401k plan, you are legally owed a written notice of your rights and obligations at least 30 days before the plan year begins.
Like a traditional 401k, a safe harbor plan can be offered by an employer of any size, and it can be combined with other retirement plans. The maximum amount an employee can contribute from their salary to a safe harbor 401k in a year is $18,500 as of 2018.
Employers opting to provide their employees with a safe harbor 401k must satisfy notification requirements, which include providing information on how the plan works and distributing the notification to employees in a timely manner.
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SIMPLE 401k
SIMPLE 401ks are used by small businesses — businesses with 100 employees or less — to provide employees with a means of saving for retirement that is efficient and cost-effective. One difference between a SIMPLE 401k and a traditional 401k is that employers do not have to undergo the annual tests that a traditional 401k requires. With a SIMPLE 401k, employer contributions must be fully vested.
Employees who are eligible to participate in a SIMPLE 401k plan can’t receive contributions or accruals with any other employer-sponsored retirement plan. The maximum amount an employee can contribute to a SIMPLE 401k in a year is $12,500 as of 2018.
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Roth 401k
A Roth 401k is an employer-sponsored retirement savings account that differs from a traditional or safe harbor 401k in that salary contributions are taxed, but withdrawals are not taxed. A person who believes they will be in a higher tax bracket when they retire than they are while they are making contributions could benefit from this type of plan.
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403b
403b plans are retirement funds offered by public schools, colleges and universities, churches and tax-exempt charities. This retirement plan is similar to a 401k plan in several ways: Employees can defer a portion of their salary into their retirement fund, and the deferred salary is generally exempt from income taxes until its distribution. However, 403b plans can also offer Roth accounts, in which case salary contributions are taxed, but funds are tax-free when distributed. Employers might or might not contribute to a 403b plan. Employees can contribute up to $18,500 from their salary each year as of 2018.
With this type of retirement plan, the employee has flexibility in the contributions made, and loans and hardship distributions allow for more options. A 403b has drawbacks for both employers and employees, however. For employees, the drawback is that you are restricted to the investment options chosen by the employer. For the employer, the major con is the high administrative costs that could come along with offering this plan.
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