What Are the Different Types of 401 (k) Plans? (And Which One's Right for Me?
Retirement plans are often a major part of company benefits packages and can be a deciding factor in accepting a job. Standard 401(k) plans are common for employers to offer, but you might see other types offered as well. Explore the types of 401(k) plans and who can benefit from each type.
All 401(k) plans are qualified retirement accounts, meaning the IRS establishes rules for contributions, withdrawals and taxes. Employers often offer this option as their retirement program. There are several types of 401(k) accounts, each with different rules and benefits for different people.
- Traditional 401(k)
- Roth 401(k)
- Safe harbor 401(k)
- SIMPLE 401(k)
- Solo 401(k)
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Most people are familiar with traditional 401(k) programs, but the other options may be better for some people. Employers might decide on a certain type of 401(k) that's more beneficial for their employees or their companies. Compare the types of 401(k) plans to determine what’s best for you.
Employers who offer traditional 401(k) plans allow employees to make automatic deductions from their paychecks. The money comes out before income taxes are calculated, which reduces your taxable income. You'll pay taxes on the money when you withdraw it, either in retirement or as an early withdrawal, which is also subject to an early withdrawal penalty of 10%.
Employers have the option to make contributions for employees. They can offer matching deductions based on what employees contribute, standard contributions for all employees or both. The employer can decide if their contributions are vested immediately or after a certain period. However, the contributions have to meet non-discrimination requirements and pass a yearly non-discrimination test.
Traditional 401(k) programs are versatile enough that they work well for most people. It makes the most sense for businesses with 20 or more employees. Employees benefit most when employers match contributions or make contributions to all employees as it helps boost their retirement savings.
A Roth 401(k) handles the taxation the opposite way. You contribute money after income taxes, so you don't get the tax benefits when you contribute. However, you don't have to pay taxes on the amount you contribute or what you earn through the investment. You can think of it as a cross between a traditional 401(k) and a Roth IRA.
This type of 401(k) is ideal for young employees who stand to have large gains in interest by the time they retire. It can also be beneficial for high earners or those who expect to be in a higher tax bracket by the time they retire. In those situations, they'll likely pay less in taxes when they contribute than they would when they take the distributions.
Regular 401(k) plans have to pass a non-discrimination test every year, but a Safe Harbor 401(k) plan isn't required to do so. Instead, the company is required to make fully vested contributions to employees' 401(k) plans.
This option is excellent for high earners who benefit from the mandatory employer contributions to increase their retirement account balances. It also makes it possible for all employees, not just those who earn a lot of money, to participate successfully.
SIMPLE 401(k) plans are for small businesses with no more than 100 employees who received compensation of $5,000 or more in the previous calendar year. It's a simplified version of the traditional 401(k) that's easier to administer and isn't required to pass the non-discrimination test. It also requires fully vested employer contributions, and employees' contributions are pre-tax. Employees can't receive contributions or benefit accruals under other plans from the employer.
SIMPLE 401(k)s are beneficial for small business owners since they're easier to administer. Their employees also benefit by having a 401(k) plan available to them when they might not otherwise get one because other 401(k) plans can be complicated.
You won't find a Solo 401(k) as an offering with a traditional employer. That's because it's a special 401(k) for employers who don't have any full-time employees. You can have a spouse or partners working for the business and still use this type of 401(k). This plan lets you contribute as both an employee and an employer. Your employer contributions are tax-deductible. Your employee contributions are taxed when you withdraw money. This plan is best for — and only available to — business owners without employees.
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