Yahoo Finance Seldom-Used Features of 401(k) Plans
Many 401(k) plan participants utilize the most popular features that these accounts offer, including getting a 401(k) match and a tax break for the contribution. But there are many other aspects of 401(k) plans that are lesser known and seldom used. And a few features of 401(k) plans are best used only in an emergency because they trigger taxes and fees. Here are some little-used features of 401(k) plans.
Roth 401(k). A Roth 401(k) permits after-tax contributions that may be withdrawn tax-free in retirement. Roth 401(k)s are growing in popularity from 46 percent of plans offering a Roth option in 2011 to 60 percent in 2015, according to Vanguard data from 1,900 retirement plans with 3.9 million participants. However, only 15 percent of participants save in the Roth 401(k) when it's available, up from 9 percent in 2011. Younger employees and those with only a few years of job tenure are the most likely to use the Roth option. "If you are in a high tax bracket today, it may make sense to defer paying income tax and going the traditional route," says Scott Frank, a certified financial planner and founder of Stone Steps Financial in Encinitas, California. "If you are just out of school or switching careers and you are in a lower tax bracket, it may make sense to consider Roth contributions."
[Read: How Your 401(k) Balance Stacks Up.]
Maxing out. Most workers are eligible to contribute up to $18,000 to a 401(k) plan in 2016. The benefit of doing this depends on your tax bracket and ranges from a tax break of $4,500 for someone in the 25 percent tax bracket to $6,300 for someone paying a 35 percent tax rate. However, only 12 percent of Vanguard 401(k) participants were able to max out their 401(k) plan in 2015. Older and higher-income employees were the most likely to fully fund their retirement account.
Catch-up contributions. Almost all 401(k) plans (97 percent) offer the opportunity to make catch-up contributions worth up to $6,000 to people age 50 and older. However, only 16 percent of 401(k) plan participants take advantage of catch-up contributions. High-income employees and those with more years on the job are the most likely to make catch-up contributions, which means a total 401(k) contribution over $18,000 and up to a maximum of $24,000 in 2016.
A wide variety of funds. In 2015, 401(k) plans offered an average of 18 funds, according to the Vanguard data. However, 401(k) participants use an average of just three funds, and half of participants contribute to only one fund. "I recommend looking at index funds, as it is the cheapest and most diverse way to invest," says Michael Solari, a certified financial planner and principal of Solari Financial Planning in Boston. "The best way to start out is to find an index tracking a U.S. large cap index, S&P 500 or Russell 1000, an international index and a bond index fund."
[See: 10 Ways to Make Your 401(k) Balance Grow Faster.]
401(k) loans. Many 401(k) plans (78 percent) offer the option to take a loan, and 16 percent of participants have an outstanding loan. When loans are allowed, the account owner may borrow up to 50 percent of the vested account balance up to a maximum of $50,000. However, the loan will likely trigger origination and maintenance fees and must be repaid quickly, typically within five years. And if you leave your job, the loan could become due sooner. "If the loan is not repaid on time, the remaining balance will be subject to income taxes and an early withdrawal penalty, if applicable," cautions Derek Tharp, a certified financial planner and founder of Conscious Capital in Cedar Rapids, Iowa. "For someone borrowing due to an emergency, subsequently losing their job and being hit with taxes and an early withdrawal penalty can be financially devastating." The average loan balance is $9,900, and low-income employees are the most likely to initiate a 401(k) loan, according to the Vanguard data.
401(k) hardship withdrawals. While 84 percent of 401(k) plans offer the option to take hardship withdrawals, only about 3 percent of 401(k) participants use them when they are offered. However, the option to take a withdrawal might be important for an individual who needs access to that cash early, as participants who use them typically withdraw 18 percent of their account balance.
Trading. You can typically change your investment selections in your 401(k) plan at any time, but most people don't. Only 9 percent of 401(k) participants traded within their accounts in 2015, down from 14 percent in 2008. Vanguard says participant trading has declined over the past 10 years due to the increased adoption of target-date funds, which automatically grow more conservative over time.
[Read: How to Avoid 401(k) Fees and Penalties.]
Investment advice. Recognizing that some employees don't have the financial planning skills or time to manage their own investments, some 401(k) plans offer online advice (39 percent), Vanguard found. However, only 6 percent of participants access these online recommendations to develop and manage their portfolio. A few employers also offer managed account advice (25 percent) and professional financial planner services (68 percent), sometimes for an additional fee, but only 10 percent of employees take advantage of either of these services.
Emily Brandon is the author of "Pensionless: The 10-Step Solution for a Stress-Free Retirement."
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