5 Myths About The 401(k)

As with many things financial, myths surrounding retirement plans abound. In order to combat these sneaky, perpetuated falsities, it is primarily essential to understand how retirement plans work.

Saving for retirement involves much more than simply stashing away a few bucks every month into the savings account attached to your checking account. It can seem burdensome, but with proper cultivation, a designated retirement savings vehicle or two can make a huge impact on your later years.

Myth 1: 401(k)s Are The Same As IRAs

401(k) plans and Individual Retirement Accounts (IRAs) are both accounts that are set up to help an individual save for retirement. 401(k)s are offered by employers, while IRAs are opened by the participant.

Eligibility: Anyone with taxable income can set up an IRA. 401(k) plans are established through an employer and therefore cannot be set up outside of that environment.
Contributions: 401(k) contributions can be made by the participant and the employer, while IRA contributions are the responsibility of the account holder alone. Furthermore, IRA contributions are determined and limited by age and income.
Taxation: Depending on the type of IRA, the account may be tax-deferred (Traditional IRAs) or have tax-free growth (Roth IRAs). 401(k) plans are considered tax-deferred since contributions are made prior to taxes being taken out (from your salary) and then taxed upon withdrawal.
Withdrawals: Typically, once the account holder reaches retirement age, withdrawals from 401(k)s are penalty-free; they are, however, taxed. Before retirement, a penalty may be incurred for withdrawals. IRA withdrawal regulations depend on the type of IRA, but in general, withdrawals can be made at any point for qualified distributions penalty-free.

Myth 2: All 401(k) Plans Are The Same

While all 401(k) plans function similarly in that they are all retirement savings vehicles, not all plans follow the exact same formula. Some employers offer matching contributions for 401(k) plans; some offer a percentage match; some do not.

Insurance broker and W.H. Black & Company President William H. Black Jr. stated, "One of the biggest misconceptions in the 401(k) world is all plans are created equal. Nothing could be further from the truth. It is this misconception that is hurting plan sponsors and plan participants alike."

Myth 3: If I Switch Jobs, My Old 401(k) Account Disappears

While 401(k) plans function as a dual investment between the participant (employee) and the offering party (employer), an employment change – either by termination or transfer to another job – does not eliminate the account or the accrued benefits. The account does not cease to exist once the offering party is no longer vested in the account.

That being said, the account cannot go on as it did before. After a job change or cease of offer (see Myth 4), the participant essentially has three options for how to proceed with the account.

Empty The Account: The participant can, with minimal penalties, withdraw all funds and close the account.
Transfer To A New Retirement Plan: If the participant switches jobs from one 401(k) provider to another, the account contents can be rolled over to the newly offered 401(k). If the participant does not wish to enroll in a new 401(k) or it is not offered, the savings can be rolled over into an Individual Retirement Account (IRA).
Leave It: Once the participant is 100 percent vested in the account, they can simply leave the account be and let it mature. A word of warning: This is not always feasible; depending on the amount in the account, the employer may have the option to automatically shift funds before they surrender their ownership percentage.

Related Link: Roth IRAs: You Wanted To Know

Myth 4: My Employer Offering The 401(k) Is Legally Bound To Keep Offering The Plan Once I Sign

Unfortunately, this is not the case. There are currently no federal or state regulations requiring employers to offer retirement plans of any sort, therefore employers can terminate their offered 401(k) plan. Furthermore, they can do this without your consent.

What is important to keep in mind, however, is that employees enrolled in 401(k) plans are protected by the virtue of how 401(k) plans are regulated. At termination, the employer must forfeit his percentage vested in all amassed benefits; the employee is then 100 percent vested in the account.

Myth 5: If I Contribute The Minimum Amount Annually, I Will Have Saved Enough For A Comfortable Retirement

Not necessarily. Many financial experts recommend upping your contributions annually. However, some annual contribution is better than none.

If you feel that you have not contributed enough over the years, there are resources to help restore balance and health to your retirement account. The IRS offers advice on how to avoid such mistakes and how to recover if oversights were made.

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