Share This Article:

What is a 401(k)?

What is a 401(k)?

Retirement savings account

A 401(k) is a tax-free retirement savings account that many employers offer to employees as an employee benefit. These accounts allow employees to deposit pre-tax income into a savings account that can only be used once an employee has reached the age of retirement. Many employers choose to contribute to these plans depending on the employee's contributions. 

When can employees withdraw from their 401(k)?

In order to ensure that employees use these tax-free accounts for retirement, the IRS requires employees to be at least 59.5 years old (55 years old if you leave your employer) to withdraw funds from their 401(k) penalty-free.  If an individual chooses to withdraw from a 401(k) before they reach the age of 59.5 years, they will be responsible for paying:

  • Federal income tax  
  • State income tax (if applicable)
  • 10% penalty 

Of course there are exceptions. Some 401(k) plans allow employees to make 401(k) hardship withdrawals. Learn more.

What's the most common 401(k) match? 

According to the National Association of Plan Advisors, the most common 401(k) structure is the simple match formula, a plan in which  the employer matches a percentage of the employee's contribution up to a certain threshold. The majority of employers using this structure offer one of two match formulas:

  • 50 cents for every $1 the employee contributes up to 6% of employee's salary
  • $1 for every $1 the employee contributes up to 4% of employee's salary


When should employees be eligible for 401(k)?

Some companies - typically smaller companies - require an employee to work for a year before they become eligible to participate in the company's 401(k). This delayed 401(k) option will likely be less attractive to quality job candidates. Other companies automatically enroll employees in the plan, but require a waiting period for the employee to be able to receive employer contribution. Finally, the best 401(k) plans automatically enroll employees in the plan upon the employee's first paycheck and require no waiting period for an employer contribution to kick in. 

First and foremost, when choosing between these three options,  employers must evaluate their financial standing. If an employer has more budgetary restrictions, it may be best to require a full year of employment before an employee becomes eligible to participate in the company's 401(k). 

Once you evaluate your financial flexibility,  you should consider your organization's turnover rate, employee satisfaction, and ease of hiring. If these are weak points for the company you may want to consider offering one of the automatic 401(k) enrollment options. 


New call-to-action

Share This Article:

Related Posts

With employees spending more time at home, many people have taken the opportunity to...

McKinsey & Company and Lean In’s 2020 Women in the Workplace study, the sixth...

In the United States, 52% of workers do not fully utilize their allotted PTO days,...

In October 2020, the IRS announced key updates to 401(k) contribution limits for 2021,...

Submit a Comment