Is Your 401(k) Plan a Turkey?

By Clifton Linton
Senior Writer, mPower

In this article: Common Features of 401(k) Plans: 50% employer match that vests in five years Waiting period for eligibility Seven to nine investment choices, at least Ability to check balances and/or change your investment choices daily Ability to borrow against your plan Ability to take hardship withdrawals

Your neighbor brags that his employer matches his 401(k)-plan contributions on $4 to $1 basis. Meanwhile, your employer offers only 50 cents on the dollar. But your plan lets you take out a loan, and his doesn’t. What’s going on here?

Like snowflakes, no two 401(k) plans are alike. Tax laws give employers lots of latitude to choose their plan’s features. How does your plan measure up against the average?

minute: read this article at a glance.

In some ways, Michael Young and Dee Dee Perkins couldn't be more different. He works for a soap company in New England. She works for an Internet startup in Seattle.

What they have in common is the fact that they're unhappy with their 401(k) plans.

A few months ago, Perkins' employer stopped contributing a match to her 401(k). Additionally, she’s disappointed with the number of investment choices and the fund family her employer has chosen.

"Our fund provider isn't rated in the top echelon," the 37-year old said. (She asked not to have her name published; Dee Dee Perkins is a pseudonym.)

Michael Young, 30, does have an employer match, of $15 a week (a figure he considers low). Still, there are other aspects of his plan that irk him. For instance, because of his low seniority with the company, he's allowed to only contribute $30 a week to the plan and the only investment choice is a savings account. The account only earns about 3% a year, Young says.

On the other hand, Sean Healy is pretty satisfied with his 401(k) plan. His employer, Visa International, matches $4 for every $1 he puts into his plan, up to 3% of his salary.

As their experiences show, not all 401(k) plans are created equal. So, in the spirit of Thanksgiving, we'd like to help you answer the question: "Is your 401(k) plan a turkey?"

Gobble, Gobble

Before you say "gobble, gobble" or "pass the gravy," read on to compare your plan to what surveys show are five common traits of 401(k) plans.

And keep in mind that each 401(k) plan is unique. Congress created rules to govern the administration of 401(k) plans, and these rules provide the framework within which every plan has to operate. But, like pilgrims charting their course to the New World, employers must decide on the specifics of their particular plans. Many employers develop their plans based on input from employees and/or consultants.

Employer match

An employer match is one of the most significant reasons to sign up for a 401(k) plan. It's free money!

Here's how they typically work. You, as an employee, make contributions to the 401(k) plan through salary deferrals. Most employers also match these contributions, up to a fixed percentage of your salary. This helps boost your balance. In some cases, employers only make a match if you contribute to the plan. In others, employers put money in the plan under your name regardless of whether you contribute or not.

About 87% of employers offer a matching contribution, according to a 1998 survey of compensation and benefits by consultant KPMG LLP.

Matches are typically made for two reasons: to reward employees, and to encourage employee participation in the plan.

The latter is a key reason why Dow Jones & Co. Inc. decided it will automatically contribute 3% of an employee's salary in a new 401(k) plan slated to open next year, says company spokesman Richard Tofel.

Indeed, KPMG's study shows that participation rates are 18% higher in 401(k) plans in which employers offer a matching contribution.

Typical Match

Employer match formulas vary. The typical match is 50% on the dollar, up to a fixed percentage of salary, according to the KPMG study. Most employers (36%) match between 2% and 4.9% of salary. Second (28%) is a match between 6% and 6.9% of salary.

For example, say your employer matches 50 cents on the dollar up to 6% of your salary. If you earned $50,000 last year and decided to contribute $3,000 (6%) for the year, your employer would put in an additional $1,500. By year-end, your 401(k) plan balance should be $4,500 plus earnings. If you contributed $5,000 (10% of salary) your employer would still only contribute $1,500, because it only matches up to 6% of your salary.

Some employers offer a match with all the trimmings and then some, like Visa International, mentioned above.

One reason Visa offers such a generous match is so it can compete for workers. "We aren't a publicly-traded company" and don't offer stock options, said Sean Healy, a Visa spokesman.

Typical Vest

While an employer match is probably the closest thing you can get to a free lunch, there's often one hitch - the money may not be immediately available to you. Often you have to work for the company for a certain amount of time before it becomes yours. Of course, your contributions are always immediately vested and you can take them with you whenever you leave your company.


Source: KPMG, LLC

There's a wide variety of vesting schedules, but the one that occurs most frequently, according to KPMG, is what's known as a five-year cliff. The money becomes available after the employee works at the same job for five years. About 31% of surveyed employers use this vesting schedule. Still, a full 20% of employers vest their contributions immediately. The maximum allowed is seven years.

Visa's plan vests over five years. "It's designed to encourage employee longevity," Healy said.

Eligibility Period

In addition to waiting for your employer match to vest, you may also have to wait to become eligible to participate in the plan. It's not uncommon to have to wait from three months to a year.

One reason why employers often use both vesting and eligibility schedules is so that they can retain workers and cut down on expenses, explains Martha Patterson, an analyst with KPMG.

"It's expensive to set up an account," she said. Companies want to be sure an employee plans to stay before going to the time and expense it takes to enroll him or her in the plan.

Investment Choices

On average, employees have 10 funds to choose from in their 401(k) plans, according to the Profit Sharing/401(k) Council of America's 42nd Annual survey of Profit Sharing and 401(k) plans. The KPMG study found that 38% of employers offered seven to nine investment options.


Source: KPMG, LLC

Popular investment options include employer stock, growth and income funds, equities mutual funds, corporate bond funds, government bond funds, international funds and money market funds.

Some participants want even more choice. When Dee Dee Perkins' employer eliminated its match, as a concession it added another three fund investment choices. That brought the offering to nine, she said, but she's still not happy.

"I'd like unlimited fund choices," she said.

A leading criticism of that strategy is that it would confuse employees who aren't savvy investors.

Still, the trend is toward more choices, not fewer, said Paul Yakoboski, senior research fellow at the Employee Benefit Research Institute (EBRI).

"You are going to see plans with 100 or 200 choices with brokerage windows that will allow investments in any mutual fund or stocks," he said. Brokerage window investment options could include any security sold by brokerages. The brokerage-window option is one of two new choices growing in popularity, the PSCA reports. The other is "lifestyle" funds. While a brokerage window option opens much of the investment universe to an employee, the lifestyle fund is designed for the employee at the other end of the spectrum, who really doesn't want to research fund choices.

Money invested in a lifestyle fund is allocated to various investments that are selected based on the employee's age. For instance, if you chose to invest in a lifestyle fund for a 30-year old, you would likely be investing in more aggressive options. If you invested in a lifestyle fund geared for a 50-year old, the fund investments would likely be more conservative.

More educated work forces tend to have more options in their plans, Yakoboski said.

Ability to check balances or change your investment choices

About 94% of plans allow employees to switch investment choices at least quarterly, KPMG says. Daily changes are allowed by 68% of plans.

And increasingly, employers are using technology to help with changes and education. About 86.1% of plans allow employees to check their 401(k) plan balances using telephone systems, according to PSCA.

The PSCA study also says 92.8% of plans use some sort of written communication (i.e. statements or newsletters) to tell employees how their investments are doing. These printed statements often describe the fund options, their investment strategy and historical performance.

But, there's a move away from paper "to toll-free phone numbers … (and) pushing people to do as much as possible via the Internet," Yakoboski said.

About 44.1% of retirement plans use Internet systems for plan administration, and most of those permit balance inquiries, the PSCA study says.

Loans or hardship withdrawals

Just over half of all 401(k) plans make loans available to employees, according to EBRI. Most often loans are permitted for first-time home purchases and to pay college tuition.

But, it could be dangerous to look at your 401(k) nest egg as a source of money to augment living expenses. If you take a loan out against your 401(k) you reduce the amount of principal working for your retirement. Also, if you don't pay back the loan you will owe income tax on the amount, and a 10% penalty if you are under 59 1/2.

In addition to loans, some plans offer hardship withdrawals to employees who need the money. In 1998, 81.8% of 401(k) plans allowed employees to take out loans and 87.6% of plans permitted hardship withdrawals, the PSCA said. There are IRS guidelines as to what constitutes an acceptable reason for an employee to make a hardship withdrawal, but it is up to the individual plan to decide, within these parameters, what (if anything) to allow. If you plan allows such a withdrawal, the money is typically used to pay for home purchases, college tuition and medical expenses.

You have to pay income tax on a hardship withdrawal, and generally a 10% penalty if you are under 59 1/2.

You have a say in the plan

Just remember, you do have a say in your plan, and you should voice any concerns to your human resources office. Remember, senior management has a stake in the plan, too! Also, before accepting a job offer with a new company, it's a good idea to ask about the 401(k) plan and mention any concerns you have.

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.

Is Your 401(k) Plan a Turkey?

By Clifton Linton
Senior Writer, mPower

In this article: Common Features of 401(k) Plans: 50% employer match that vests in five years Waiting period for eligibility Seven to nine investment choices, at least Ability to check balances and/or change your investment choices daily Ability to borrow against your plan Ability to take hardship withdrawals

Your neighbor brags that his employer matches his 401(k)-plan contributions on $4 to $1 basis. Meanwhile, your employer offers only 50 cents on the dollar. But your plan lets you take out a loan, and his doesn’t. What’s going on here?

Like snowflakes, no two 401(k) plans are alike. Tax laws give employers lots of latitude to choose their plan’s features. How does your plan measure up against the average?

minute: read this article at a glance.

In some ways, Michael Young and Dee Dee Perkins couldn't be more different. He works for a soap company in New England. She works for an Internet startup in Seattle.

What they have in common is the fact that they're unhappy with their 401(k) plans.

A few months ago, Perkins' employer stopped contributing a match to her 401(k). Additionally, she’s disappointed with the number of investment choices and the fund family her employer has chosen.

"Our fund provider isn't rated in the top echelon," the 37-year old said. (She asked not to have her name published; Dee Dee Perkins is a pseudonym.)

Michael Young, 30, does have an employer match, of $15 a week (a figure he considers low). Still, there are other aspects of his plan that irk him. For instance, because of his low seniority with the company, he's allowed to only contribute $30 a week to the plan and the only investment choice is a savings account. The account only earns about 3% a year, Young says.

On the other hand, Sean Healy is pretty satisfied with his 401(k) plan. His employer, Visa International, matches $4 for every $1 he puts into his plan, up to 3% of his salary.

As their experiences show, not all 401(k) plans are created equal. So, in the spirit of Thanksgiving, we'd like to help you answer the question: "Is your 401(k) plan a turkey?"

Gobble, Gobble

Before you say "gobble, gobble" or "pass the gravy," read on to compare your plan to what surveys show are five common traits of 401(k) plans.

And keep in mind that each 401(k) plan is unique. Congress created rules to govern the administration of 401(k) plans, and these rules provide the framework within which every plan has to operate. But, like pilgrims charting their course to the New World, employers must decide on the specifics of their particular plans. Many employers develop their plans based on input from employees and/or consultants.

Employer match

An employer match is one of the most significant reasons to sign up for a 401(k) plan. It's free money!

Here's how they typically work. You, as an employee, make contributions to the 401(k) plan through salary deferrals. Most employers also match these contributions, up to a fixed percentage of your salary. This helps boost your balance. In some cases, employers only make a match if you contribute to the plan. In others, employers put money in the plan under your name regardless of whether you contribute or not.

About 87% of employers offer a matching contribution, according to a 1998 survey of compensation and benefits by consultant KPMG LLP.

Matches are typically made for two reasons: to reward employees, and to encourage employee participation in the plan.

The latter is a key reason why Dow Jones & Co. Inc. decided it will automatically contribute 3% of an employee's salary in a new 401(k) plan slated to open next year, says company spokesman Richard Tofel.

Indeed, KPMG's study shows that participation rates are 18% higher in 401(k) plans in which employers offer a matching contribution.

Typical Match

Employer match formulas vary. The typical match is 50% on the dollar, up to a fixed percentage of salary, according to the KPMG study. Most employers (36%) match between 2% and 4.9% of salary. Second (28%) is a match between 6% and 6.9% of salary.

For example, say your employer matches 50 cents on the dollar up to 6% of your salary. If you earned $50,000 last year and decided to contribute $3,000 (6%) for the year, your employer would put in an additional $1,500. By year-end, your 401(k) plan balance should be $4,500 plus earnings. If you contributed $5,000 (10% of salary) your employer would still only contribute $1,500, because it only matches up to 6% of your salary.

Some employers offer a match with all the trimmings and then some, like Visa International, mentioned above.

One reason Visa offers such a generous match is so it can compete for workers. "We aren't a publicly-traded company" and don't offer stock options, said Sean Healy, a Visa spokesman.

Typical Vest

While an employer match is probably the closest thing you can get to a free lunch, there's often one hitch - the money may not be immediately available to you. Often you have to work for the company for a certain amount of time before it becomes yours. Of course, your contributions are always immediately vested and you can take them with you whenever you leave your company.


Source: KPMG, LLC

There's a wide variety of vesting schedules, but the one that occurs most frequently, according to KPMG, is what's known as a five-year cliff. The money becomes available after the employee works at the same job for five years. About 31% of surveyed employers use this vesting schedule. Still, a full 20% of employers vest their contributions immediately. The maximum allowed is seven years.

Visa's plan vests over five years. "It's designed to encourage employee longevity," Healy said.

Eligibility Period

In addition to waiting for your employer match to vest, you may also have to wait to become eligible to participate in the plan. It's not uncommon to have to wait from three months to a year.

One reason why employers often use both vesting and eligibility schedules is so that they can retain workers and cut down on expenses, explains Martha Patterson, an analyst with KPMG.

"It's expensive to set up an account," she said. Companies want to be sure an employee plans to stay before going to the time and expense it takes to enroll him or her in the plan.

Investment Choices

On average, employees have 10 funds to choose from in their 401(k) plans, according to the Profit Sharing/401(k) Council of America's 42nd Annual survey of Profit Sharing and 401(k) plans. The KPMG study found that 38% of employers offered seven to nine investment options.


Source: KPMG, LLC

Popular investment options include employer stock, growth and income funds, equities mutual funds, corporate bond funds, government bond funds, international funds and money market funds.

Some participants want even more choice. When Dee Dee Perkins' employer eliminated its match, as a concession it added another three fund investment choices. That brought the offering to nine, she said, but she's still not happy.

"I'd like unlimited fund choices," she said.

A leading criticism of that strategy is that it would confuse employees who aren't savvy investors.

Still, the trend is toward more choices, not fewer, said Paul Yakoboski, senior research fellow at the Employee Benefit Research Institute (EBRI).

"You are going to see plans with 100 or 200 choices with brokerage windows that will allow investments in any mutual fund or stocks," he said. Brokerage window investment options could include any security sold by brokerages. The brokerage-window option is one of two new choices growing in popularity, the PSCA reports. The other is "lifestyle" funds. While a brokerage window option opens much of the investment universe to an employee, the lifestyle fund is designed for the employee at the other end of the spectrum, who really doesn't want to research fund choices.

Money invested in a lifestyle fund is allocated to various investments that are selected based on the employee's age. For instance, if you chose to invest in a lifestyle fund for a 30-year old, you would likely be investing in more aggressive options. If you invested in a lifestyle fund geared for a 50-year old, the fund investments would likely be more conservative.

More educated work forces tend to have more options in their plans, Yakoboski said.

Ability to check balances or change your investment choices

About 94% of plans allow employees to switch investment choices at least quarterly, KPMG says. Daily changes are allowed by 68% of plans.

And increasingly, employers are using technology to help with changes and education. About 86.1% of plans allow employees to check their 401(k) plan balances using telephone systems, according to PSCA.

The PSCA study also says 92.8% of plans use some sort of written communication (i.e. statements or newsletters) to tell employees how their investments are doing. These printed statements often describe the fund options, their investment strategy and historical performance.

But, there's a move away from paper "to toll-free phone numbers … (and) pushing people to do as much as possible via the Internet," Yakoboski said.

About 44.1% of retirement plans use Internet systems for plan administration, and most of those permit balance inquiries, the PSCA study says.

Loans or hardship withdrawals

Just over half of all 401(k) plans make loans available to employees, according to EBRI. Most often loans are permitted for first-time home purchases and to pay college tuition.

But, it could be dangerous to look at your 401(k) nest egg as a source of money to augment living expenses. If you take a loan out against your 401(k) you reduce the amount of principal working for your retirement. Also, if you don't pay back the loan you will owe income tax on the amount, and a 10% penalty if you are under 59 1/2.

In addition to loans, some plans offer hardship withdrawals to employees who need the money. In 1998, 81.8% of 401(k) plans allowed employees to take out loans and 87.6% of plans permitted hardship withdrawals, the PSCA said. There are IRS guidelines as to what constitutes an acceptable reason for an employee to make a hardship withdrawal, but it is up to the individual plan to decide, within these parameters, what (if anything) to allow. If you plan allows such a withdrawal, the money is typically used to pay for home purchases, college tuition and medical expenses.

You have to pay income tax on a hardship withdrawal, and generally a 10% penalty if you are under 59 1/2.

You have a say in the plan

Just remember, you do have a say in your plan, and you should voice any concerns to your human resources office. Remember, senior management has a stake in the plan, too! Also, before accepting a job offer with a new company, it's a good idea to ask about the 401(k) plan and mention any concerns you have.

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.