LAST REVIEWED Apr 23 2020 16 MIN READ
By Damian Davila
Finding the best 401(k) plans may seem relatively straightforward, but plans can vary drastically. Some offer more benefits to the employers, some to the employees, and others strike a healthy balance.
To help you evaluate how your personal employer-sponsored 401(k) stacks up, we’ll dive into the qualities that plans can offer and which ones you should prioritize. While you may not have much say in which specific 401(k) provider your employer chooses, the features below should be possible with most providers. Here at Human Interest, we offer all of these features and more as part of our 401(k) product.
The first sign of a top 401(k) is that, as an employee, you’re eligible to sign up and contribute to your account right away. In its How America Saves report from 2017, Vanguard indicates that 67% of plans offer immediate eligibility for employee contributions, up from 58% in 2012.
Some employers require you to wait six months or even a year of employment before you’re eligible to save for retirement. Remember that every year you can contribute up to $20,500 ($27,000 if age 50 and over) and once the contribution deadline is up, you can never contribute that amount ever again! Every month counts: even waiting three months can cost you a tremendous amount of money. Luckily, many employers have noticed that immediate eligibility is important for employees, so only 11% of plan sponsors require one year of service.
Great employer match contributions
This one is provider-agnostic, and more a decision that has to do with your company’s budget and attitude towards employee compensation and benefits. According to a 2015 Glassdoor poll, 31% of polled employees value an employer-sponsored 401(k) over a salary raise. This is why employer contributions are such a valuable recruiting tool to attract and retain talent. Some people say that there’s no such thing as a free lunch, but employer contributions to your retirement account sure feel like it. Here’s what to look for:
1. Easy eligibility requirements for the match
Nowadays, employer contributions have become the norm: in 2016, Vanguard reported that 94% of its 401(k)s provided employer contributions, up from 91% in 2013.
A lack of employer contributions is a red flag, but does that mean that you should just dump your 401(k) when there’s no match? Not necessarily. Depending on your level of income, schedule of fees from alternative ways to save for retirement, and list of investment options from your 401(k), you can determine if you should contribute to your 401(k) even if there’s no match.
2. Strong matching contribution formula
In 2016, Vanguard administered more than 200 distinct formulas for employer matching. With 70% of plans using it, the most popular formula is $0.50 per dollar on 6% of pay. Under this single-tier formula, an employee making $50,000 per year would get up to $1,500 in matching contributions.
The second most popular formula for employer matching contributions (22% of plans) is $1.00 per dollar on the first 3% of pay and $0.50 on the next 2% of pay. Under this multi-tier formula, the same worker in our previous example would receive up to $2,000 in matching contributions. Keep in mind that 5% of plans using a single- or multi-tier formula put a cap of $2,000 for matching contributions.
In 2016, plans with matching contributions offered matches ranging from 1% to 6% of pay. The average and median promised match were 4.1% and 4.0%, respectively. These guidelines allow you to establish how your workplace’s matching contributions formula stacks up against that from the “competition.”
3. Quick vesting of employer contributions
Employer contributions are great, but also note the wait time until those contributions become 100% yours. In 2016, 47% of Vanguard contribution plans provided immediate vesting of employer-matching contributions, 17% of them provided 5-year graded vesting, 13% of them provided 6-year graded vesting, and 10% of them provided 3-year cliff vesting.
A 401(k) offering immediate vesting is preferable to one requiring you to wait a minimum number of years (cliff vesting) or gradually granting you a percentage of ownership (graded vesting). Vanguard data reveals that small businesses are the most likely to require longer vesting periods for employer contributions and that businesses of all sizes require longer vesting periods for other types of employer contributions, such as profit-sharing and company stock.
4. Low employee contributions minimum for employer match
In 2016, the average value of employee contributions to maximize employer match was 6.9% of pay, according to Vanguard data. Here’s a breakdown of how much plans require employees to contribute to maximize the match (in order of popularity):
Employer Contribution for Maximum Match
|(% of Pay)||Percentage of 401(k) Plans|
|10.00% and over||→||6%|
In summary, look for immediate eligibility to receive employer matching contributions, use of a sensible matching formula, and minimum wait time for vesting.
Lowest possible 401(k) fees
Your investment options and applicable fees go hand in hand. Generally, Vanguard funds offer an average 27.4 investment options as of 2016, but that number falls to 17.9 when all available target-date funds are counted as a single offering. This is an important criterion to evaluate your available investment options. Make sure to ask your plan sponsor about how many different classes of funds are available.
The explosion in popularity of target-date funds can be traced to 2006 when the Pension Protection Act officially assigned these funds the status of qualified default investment alternative (QDIA). In 2016, 96% of 401(k)s designating a QDIA made a target-date fund the default investment option. Despite the convenience, such funds provide to novice investors, target-date funds have several disadvantages, including high fees and highly variable historical returns.
This is why more and more 401(k) providers are offering an index “core” of passively-managed funds covering U.S. equities, non-U.S. equities, U.S. taxable funds, and cash. In 2016, 57% of Vanguard plans offered an index core covering at least these four options, up from 33% in 2007. A great 401(k) plan should give you access to index funds because they have lower expense ratios than those from actively-managed funds and tend to outperform actively-managed funds.
Some financial experts suggest that employees should choose funds with annual expense ratios between 0.10% and 0.30%. And for good reason: this means that you could expect to pay between $10 and $30 per year for every $10,000.
Plans that focus on low-cost index funds are able to drive down the plan cost for employees. For example, Human Interest provides access to low-cost index funds, including Vanguard index funds in the Admiral share class which have annual expense ratios starting at 0.04% (that’s just $4 per year for every $10,000!). And with a combined 0.57%1 cost, a Human Interest plan is less than half of the national average for investment expenses of 1.64%2.
For older employees: Are catch-up contributions allowed?
Virtually all Vanguard plans (98%) allowed workers age 50 and over to make catch-up contributions in 2016. That’s an extra up to $6,000 in employee contributions in 2017. For workers age 50 and over, this is a must-have feature for their 401(k) plans.
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For younger employees: Is there a Roth 401(k) option?
More and more 401(k)s are allowing holders to contribute with after-tax dollars. In 2016, 65% of Vanguard plans offered Roth 401(k) contributions, up from 49% in 2012. For workers just starting out their careers, taking the tax hit on their retirement savings makes a lot of sense because they have a lot of upside income potential. That way all after-tax contributions grow tax free forever and can be withdrawn tax-free starting age 59 ½ (as long as the plan has been held for at least five years).
(Note: Even if you choose a Roth 401(k) option, all employer contributions to your 401(k) will be made on a tax-deferred basis. This is a requirement from the IRS.)
For more info, review our guide on Roth 401(k) vs. Traditional 401(k).
For all employees: Good customer service and financial literacy training
Here are four key signs of outstanding customer service.
1. Smooth signup and setup process from the 401(k) provider
Just like in any race, saving for retirement can be easier with a great start. Wouldn’t you prefer to have found out three years earlier that a fund could have provided you the same exposure to U.S. equities at half the cost of your current choice? That’s why you have to look for a plan that does more than just hand you a generic brochure. The best 401(k) plans provide introductory training on the basics of your 401(k), particularly on how to make the most of your money for your given situation (everyone’s finances are different!).
2. Ability to access your plan and complete transactions online
About every 7 in 10 American workers with a Vanguard plan register (or are already registered) for Internet access to their plans. And for good reason: convenience. In 2016, 88% of Vanguard plan holders completed transactions online, up from 82% in 2012. Online access is an easy way to get the job done without being upsold and have to pay commission fees. Don’t think that dealing with a computer is subpar vs. dealing with a person. Some digital platforms like Human Interest, provide great features, such as 401(k) automatic rebalancing and an easy online dashboard, for free.
3. Free rollovers (no nickel-and-diming)
As a great as a 401(k) plan can be, there might come a time that you have part ways with the employer sponsoring that plan, or if you want to bring in money from another account. When that time comes, you don’t want to be hit with a fee for a 401(k) rollover. It’s your money, you shouldn’t be charged for doing what you want with it!
4. Easy-to-understand, complete fee disclosures
Since 2012, the Fee Disclosure Act requires plan administrators to release quarterly fee reports. A lack of fees is one of the most common 401(k) myths there is. While it’s understandable that a plan administrator must charge something to cover the necessary expenses of running the plan, it’s not ok that those fees aren’t fully disclosed on a rolling basis. Knowledge is power. Once you find out your plan fees, you can often take steps to try to reduce them.
What about the employer’s perspective? What’s the best 401(k) plan for a small business?
For the owner of a small- or medium-sized business, reading this list of qualities of a great 401(k) plan could make them wonder if they could really afford to offer a quality plan at all. The more features a plan has, the higher the bar for fiduciary and compliance responsibilities (think of hardship withdrawals and international employees wanting to contribute to their 401(k) as foreign nationals!). Bringing a retirement specialist in-house may be cost-prohibitive for some businesses.
Outsourcing 401(k) administration is a great way to offer a solid 401(k) with the qualities that your current and future employees are looking for. Look for a 401(k) administrator that provides flexible plan design and options, including eligibility, matching contributions, vesting, and profit-sharing. If you’re a small business owner, make sure to look for a plan administrator providing support for filing Form 5500 to satisfy annual reporting requirements under ERISA and the Internal Revenue Code.
Here are some references for more information on outsourcing 401(k) administration:
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Damian Davila is a Honolulu-based writer with an MBA from the University of Hawaii. He enjoys helping people save money and writes about retirement, taxes, debt, and more.