401k Glossary

A 401(k) plan is a type of employer-sponsored retirement savings plan in the United States. It allows employees to save and invest a portion of their paychecks before taxes are taken out. Taxes aren't paid until the money is withdrawn from the account.

Here are the key features of a 401(k) plan:

1. Pre-Tax Contributions: The money that you contribute to a 401(k) plan generally comes out of your paycheck before taxes are deducted. This reduces your taxable income for the year, which in turn, reduces your overall tax bill.
2. Employer Match: Many employers will match a portion of their employees' 401(k) contributions, up to a certain percentage of their salary. This is essentially free money and can significantly boost the growth of your retirement savings.
3. Tax-Deferred Growth: The money in your 401(k) grows tax-deferred, meaning you don't pay taxes on any investment earnings until you withdraw the money in retirement.
4. Penalties for Early Withdrawal: If you withdraw money from your 401(k) before age 59.5, you'll typically have to pay a 10% early withdrawal penalty, in addition to regular income taxes. However, there are some exceptions to this rule.
5. Required Minimum Distributions (RMDs): Once you reach age 72, you must start taking required minimum distributions from your 401(k), which are then taxed as ordinary income.

There are two main types of 401(k) plans: traditional 401(k) and Roth 401(k). In a traditional 401(k), contributions are made pre-tax, and withdrawals in retirement are taxed. In a Roth 401(k), contributions are made after tax, but withdrawals in retirement are tax-free. The choice between the two often depends on whether you think your tax rate will be higher or lower in retirement than it is now.

The Annual Contribution Limit refers to the maximum amount of money that an individual can contribute to certain types of accounts, such as retirement accounts (401k, IRA, etc.), Health Savings Accounts (HSAs), or education savings accounts (529 plans) in a given year.

These limits are typically set by governmental regulatory bodies such as the Internal Revenue Service (IRS) in the United States, and they can change from year to year based on inflation and changes to tax law. For example, the annual contribution limit for a 401(k) plan in the United States was $19,500 for individuals under 50, and $26,000 for individuals 50 and over (including a $6,500 catch-up contribution).

Exceeding these limits can result in tax penalties, so it's important to monitor contributions to these types of accounts closely.

A beneficiary in the context of a 401(k) is the person or entity designated to receive the assets in the 401(k) account upon the death of the account holder.

The account holder can typically choose anyone as a beneficiary, including a spouse, children, a trust, or a charity. In some cases, if the account holder is married, the spouse may have certain rights to the 401(k) assets unless they specifically waive those rights.

The beneficiary designation is important because it generally overrides any contrary instructions in a will or trust. Therefore, it's crucial to keep beneficiary designations up to date, particularly after major life events like marriage, divorce, the birth of a child, or the death of a previously named beneficiary.

In the event of the account holder's death, the named beneficiary would need to contact the 401(k) plan administrator to claim the assets. The tax implications and distribution options for the beneficiary can vary depending on their relationship to the deceased and the specific rules of the plan.

A catch-up contribution refers to the extra amount that individuals aged 50 or older are allowed to contribute to their retirement savings accounts. It is a provision that allows these individuals to make additional contributions to certain tax-advantaged accounts beyond the standard annual limit.

The idea behind catch-up contributions is to help individuals who may be nearing retirement age and are behind in their savings to have a chance to 'catch up' and save more in a shorter timeframe. This provision is applicable to various types of retirement accounts, such as 401(k)s, 403(b)s, individual retirement accounts (IRAs), and certain other types of plans.

The catch-up contribution limit for 401(k), 403(b), most 457 plans, and the federal government's Thrift Savings Plan was $6,500. For IRAs, the catch-up contribution limit was $1,000. However, these limits can change over time due to inflation adjustments, so it's always a good idea to verify the current limits from a reliable source.

In the context of a 401(k) retirement savings plan, a "company match" refers to the contributions that an employer makes to match an employee's own contributions to their 401(k) account. The specific terms and conditions of the company match can vary from one employer to another, but it's typically expressed as a percentage of the employee's contributions up to a certain limit.

For example, an employer might offer a 100% match on the first 3% of the employee's salary that they contribute to their 401(k), and then a 50% match on the next 2%. This means that if an employee contributes 5% of their salary to the 401(k), the employer will contribute an additional 4% of the employee's salary (3% for the first part and 1% for the second part).

The company match is a form of employer-sponsored retirement savings incentive, and it essentially represents free money that can help employees build their retirement savings more quickly. However, there might be certain requirements or conditions attached, such as a vesting schedule that specifies how long the employee must work for the company before they gain full ownership of the employer-matching contributions.

Contribution limits for 401(k) plans are set by the Internal Revenue Service (IRS) and can change from year to year. Therefore, employees should check the most recent guidelines to make sure they are maximizing their contributions and employer match.

A "Default Investment" in the context of the 401k industry refers to the investment option that a participant's contributions will automatically go towards if they do not actively choose an investment option for their 401k plan.

The Pension Protection Act of 2006 introduced the concept of Qualified Default Investment Alternatives (QDIAs). A QDIA is a specific type of default investment that offers plan sponsors liability protection for the investment outcomes of participants who do not make active investment elections.

QDIAs generally include:

1. Target-date funds (TDFs): These funds adjust the allocation of investments from more aggressive to more conservative as the target retirement date (usually the year in the fund's name) approaches.
2. Balanced funds: These funds invest in a mix of stocks and bonds with the aim to achieve a balance of income and growth.
3. Managed accounts: These are investment services where a professional manager adjusts the allocation of assets over time based on the participant's age, risk tolerance, and other factors.

The Department of Labor (DOL) has provided guidelines for the selection and monitoring of QDIAs, and plan sponsors are required to notify participants of their rights and the circumstances under which their assets may be invested in a QDIA.

A Defined Contribution Plan is a type of retirement plan in which the employer, employee, or both make regular contributions, and the future benefits of the plan are not guaranteed. The value of the plan is dependent on the amount of money contributed and the performance of the investments.

The most common examples of defined contribution plans include 401(k) plans, 403(b) plans, employee stock ownership plans, and profit-sharing plans in the United States.

In a Defined Contribution Plan, the risk and reward associated with the plan's investments are typically managed by the employee, not the employer. This means the retirement income depends on the investment's performance, and if the investments do not perform well, the employee may end up with less money than expected for retirement.

Contrast this with a Defined Benefit Plan, where the employer guarantees a specific retirement benefit amount to the employee based on a set formula, often involving the employee's salary, years of service, and age. In a Defined Benefit Plan, the employer bears the investment risk.

In the context of the 401(k) industry, a "distribution" refers to the disbursement of funds from a 401(k) retirement plan. This can occur under various circumstances, such as when an individual reaches the age of 59.5, which is the minimum age set by the IRS for penalty-free withdrawals, or upon the participant's retirement, disability, or death.

A distribution could also occur when an individual decides to take an early withdrawal, although this generally incurs a penalty. The penalty is typically 10% of the amount withdrawn, in addition to the withdrawal being subject to regular income tax.

Distributions can take various forms, including:

1. Lump-Sum Distributions: This is when the entire amount in the 401(k) account is withdrawn at once.
2. Rollovers: This is when the funds in a 401(k) account are moved into another retirement account, like an IRA or a new employer's 401(k) plan.
3. Annuity Payments: In some cases, the 401(k) plan may allow the account holder to receive distributions in the form of regular annuity payments, providing a steady stream of income over a period of time.
4. Required Minimum Distributions (RMDs): These are mandatory distributions that must begin by April 1 of the year following the year in which the account holder reaches age 72 (or 70.5 if you reached 70.5 before Jan 1, 2020), or when the account holder retires, whichever is later.

The tax and penalty implications of a distribution depend on the individual's age, the reason for the distribution, and whether the distribution is rolled over into another retirement account.

In the context of 401(k) retirement savings plans, diversification refers to the investment strategy of spreading your contributions among different types of investment options to reduce risk and potentially increase returns.

These options can include various asset classes such as stocks, bonds, mutual funds, index funds, ETFs, and potentially others, depending on the specific plan offered by your employer. Within these asset classes, you can further diversify by industry, company size, geographical region, and so on.

The idea behind diversification is that different types of investments perform well under different market conditions. By diversifying, you're not putting all your eggs in one basket, so to speak. If one investment underperforms, others might do well, thereby balancing out potential losses.

The specific level and method of diversification that's right for an individual depends on a number of factors, including their age, risk tolerance, financial goals, and the time left until retirement. It's often recommended to consult with a financial advisor to develop a suitable investment strategy.

An Early Distribution Penalty refers to the additional tax that may be charged on certain types of withdrawals from a tax-advantaged retirement account before the account owner reaches a certain age, typically 59 1/2 years old. This penalty is intended to discourage individuals from withdrawing their retirement savings too soon.

For example, if you withdraw money from an Individual Retirement Account (IRA) or a 401(k) plan before age 59 1/2, you may have to pay a 10% early withdrawal penalty in addition to regular income tax on the amount withdrawn. There are, however, certain exceptions to this rule, such as when the funds are used for qualified higher education expenses, certain medical expenses, or a first-time home purchase. It's always recommended to consult with a tax professional or financial advisor to understand the implications of an early distribution from a retirement account.

An "Early Withdrawal Penalty" refers to a financial penalty that an account holder may incur for withdrawing money from their 401(k) retirement account before reaching a certain age, typically 59.5 years old in the United States.

The early withdrawal penalty for 401(k)s was generally 10% of the amount withdrawn, in addition to the regular income tax that would be due on the withdrawal. This penalty is intended to discourage people from using their retirement savings before they retire.

However, there were exceptions to this rule, for instance, in cases of financial hardship, disability, or certain specific medical expenses. The CARES Act in 2020 also temporarily waived the early withdrawal penalty for those impacted by the COVID-19 pandemic.

The exact rules and penalties can vary, and changes can be made by regulatory authorities, so it's always best to consult with a financial advisor or retirement plan administrator to understand the latest rules and penalties.

An elective deferral refers to the portion of an employee's pre-tax earnings that they choose to contribute to their 401(k) retirement plan. These contributions are deducted directly from the employee's paycheck and are not subject to income tax at the time of contribution.

Elective deferrals are "elective" because the employee chooses the amount they wish to contribute, up to a maximum limit set by the Internal Revenue Service (IRS). This limit was $19,500 per year for individuals under 50 years old, and $26,000 for those 50 or older (including a catch-up contribution of $6,500).

The advantage of elective deferrals is the tax benefit. Since these contributions are made with pre-tax dollars, they lower the employee's taxable income for the year, potentially placing them in a lower tax bracket. Additionally, the money in the 401(k) grows tax-free until it is withdrawn during retirement when it is taxed as ordinary income.

Remember, tax laws and regulations can change and the information given here may be outdated. It is always recommended to consult with a tax advisor or financial planner to understand the current rules and how they apply to individual situations.

They typically include factors such as:

1. Age: The employee must be at least 21 years old, although some employers allow younger employees to participate.
2. Length of Service: The employee often must have a certain length of service with the employer. This can range from immediate eligibility upon hiring to requiring one or two years of service.
3. Hours Worked: The employee may need to work a certain number of hours per year. The IRS generally requires that employees who work 1,000 hours or more in a year be allowed to participate.
4. Union Membership: If an employee is part of a union, their eligibility may depend on the specific terms of their union contract.
5. Part-Time vs. Full-Time Status: Some employers only allow full-time employees to participate in the 401(k) plan.
6. Waiting Period: Some employers impose a waiting period before new employees can participate in the 401(k) plan.

If an employee meets the eligibility requirements for a 401(k) plan, they can then begin contributing to the plan. The amount that an employee can contribute is generally limited by the IRS.

Eligibility for a 401(k) plan is an important consideration for both employers and employees. By understanding the eligibility requirements, employers can ensure that their employees are able to participate in the plan and save for retirement. Employees can also use this information to determine if they are eligible to participate in their employer's 401(k) plan.

The Employee Retirement Income Security Act (ERISA) is a federal law that was enacted in 1974 to set minimum standards for most voluntarily established pension and health plans in private industry to provide protection for individuals in these plans. It is a key part of the 401(k) industry because it establishes the legal framework for the administration of these retirement plans.

The goals of ERISA include:

1. Ensuring that employers uphold their fiduciary duties to the retirement plan and to its participants. This means that they must act in the best interests of the plan's beneficiaries.
2. Setting standards for plan funding to make sure that employers are properly funding the plan and not putting the employees' retirement savings at risk.
3. Mandating that plan participants are provided with detailed information about their plan, including its funding status, its investments, and its management.
4. Providing for fair processes for participants who feel their rights under the plan have been violated or who wish to appeal a denial of benefits.
5. Establishing the Pension Benefit Guaranty Corporation (PBGC), a government entity that insures certain types of pension plans.

In the context of a 401(k) plan, ERISA is crucial because it provides protections for the employees who participate in the plan. It helps to ensure that the money that they contribute to the plan will be there when they retire, and that they are provided with the information and the fair processes they need to protect their retirement savings.

An employer-sponsored retirement plan is a type of investment plan that allows employees to save for retirement with help from their employer. This term can refer to several different types of plans, but one of the most common is the 401(k) plan.

In the 401(k) industry, an employer-sponsored retirement plan works like this:

• An employee can choose to defer a portion of their pre-tax salary into their 401(k) account. Some plans also allow post-tax contributions.
• The money in the account is then invested, typically in a selection of mutual funds, stocks, bonds, or other assets.
• The funds in the account grow tax-free until retirement, at which point withdrawals are taxed as ordinary income.
• Many employers offer a matching contribution up to a certain percentage of the employee's salary. This is essentially "free money" that helps the employee's retirement savings grow even faster.
• 401(k) plans are subject to certain regulations by the IRS, including limits on how much can be contributed in a year and penalties for early withdrawals before a certain age (usually 59 1/2).

Other types of employer-sponsored retirement plans include 403(b) plans for non-profit employees, 457 plans for government employees, and the Thrift Savings Plan for federal employees. These plans work similarly to 401(k) plans but have their own specific rules and regulations.

In all cases, the goal of an employer-sponsored retirement plan is to encourage long-term savings and provide financial security in retirement. The 401(k) industry, which includes financial advisors, investment companies, and retirement plan administrators, supports these goals by managing these plans and helping participants make informed investment decisions.

In the 401k industry, "enrollment" refers to the process by which employees of a company or organization sign up to participate in their employer-sponsored 401k plan. During enrollment, employees typically choose how much of their salary they want to contribute to the plan, how those contributions will be invested, and any other plan options that are available to them. Enrollment may be automatic, where employees are enrolled by default but can opt-out if they choose, or it may require active participation by the employee to sign up. Effective enrollment processes are critical to the success of a 401k plan, as they help ensure that employees are taking advantage of the benefits of the plan and saving adequately for retirement.

A fiduciary is an individual or organization that has a legal or ethical duty to act in the best interest of another party—in this case, the participants of a 401k plan. This duty is known as a fiduciary duty, and it is the highest standard of care under the American legal system.

Fiduciaries in the 401k industry might include plan trustees, plan administrators, and investment advisors, among others. Their responsibilities can include:

1. Investment Oversight: Fiduciaries are often responsible for selecting and monitoring the investment options available within the 401k plan. They must ensure that these options are diversified and prudent, given the needs and risk tolerance of the plan participants.
2. Administrative Oversight: Fiduciaries must also ensure that the 401k plan is administered correctly and in compliance with all relevant laws and regulations. This might involve everything from making sure that contributions are deposited in a timely manner to ensuring that the plan's record-keeping is accurate.
3. Fee Reasonableness: Fiduciaries must ensure that any fees charged to the plan or its participants are reasonable and necessary for the services provided.
4. Acting in Participants' Best Interest: Above all, fiduciaries are required to act in the best interest of the plan participants. This means avoiding conflicts of interest, making decisions that benefit the participants, and putting the participants' needs above their own or those of the company.

Failing to meet these obligations can result in serious legal consequences for the fiduciaries involved. Thus, it's important for fiduciaries to carefully understand and carry out their responsibilities, and for plan participants to be aware of these obligations and hold their fiduciaries accountable.

A Financial Advisor is a professional who provides guidance to individuals and companies on managing their 401(k) retirement plans.

Financial Advisors in this context often perform the following roles:

1. Investment Guidance: They assist clients in understanding the various investment options available within their 401(k) plans, such as mutual funds, stocks, bonds, and other securities. They can help clients align these investment choices with their financial goals, risk tolerance, and time horizon.
2. Retirement Planning: They aid clients in determining how much they need to save in their 401(k) to meet their retirement income goals. This often involves creating a comprehensive retirement plan that considers other income sources, like Social Security or pensions.
3. Plan Setup and Management: For businesses, financial advisors often assist in setting up and managing 401(k) plans for employees. This may involve selecting the plan's investment offerings, ensuring the plan complies with legal and regulatory requirements, and providing financial education to employees.
4. Account Review and Adjustment: Financial advisors regularly review clients' 401(k) accounts to ensure they're on track to meet their goals. If necessary, they may recommend adjustments, such as reallocating investments or changing contribution levels.
5. Tax Advice: Given the tax-advantaged nature of 401(k)s, financial advisors provide advice on how to maximize these benefits and navigate issues like withdrawal penalties and required minimum distributions.

Overall, the role of a Financial Advisor in the 401(k) industry is to use their expertise to help clients make informed decisions about their retirement savings and investment strategies. It's important to note that financial advisors should be fiduciaries, meaning they are legally obligated to act in their client's best interests.

The Fund Expense Ratio in the context of the 401(k) industry refers to the total percentage of fund assets used for administrative, management, advertising, and all other expenses. An expense ratio is an annual fee expressed as a percentage of your investment — or, as the term implies, the ratio of your assets that go toward expenses.

For example, an expense ratio of 0.6% per year means that each year 0.6% of the fund's total assets will be used to cover expenses. If your investment in the fund is $10,000, for instance, you would pay about $60 annually.

The expense ratio doesn't come out of your account directly. Instead, it's deducted from the return you're quoted — it's already been subtracted by the time you see what your fund returned for the year.

Expense ratios matter because they can significantly affect both the total return and long-term growth of your investment. A high expense ratio will erode returns over time. Therefore, for 401(k) participants, it's important to be aware of the expense ratios of the different funds options within their 401(k) plan.

A hardship withdrawal is a feature of some 401(k) plans that allows you to withdraw funds from your account while you're still employed, but only if you're facing a significant financial hardship that's defined by the IRS and your plan's terms and conditions.

Typically, the IRS defines a hardship as an immediate and heavy financial need, and the amount you withdraw must be necessary to satisfy that need. This can include certain medical expenses, costs related to the purchase of a principal residence, tuition and education expenses, payments to prevent eviction from or foreclosure on a principal residence, funeral expenses, and certain expenses for the repair of damage to a principal residence.

However, it's important to remember that hardship withdrawals are not like loans against your 401(k), they can't be paid back. Once the money is taken out, it's no longer invested and growing tax-free for retirement. Plus, you'll owe income taxes on the withdrawal, and if you're under age 59 1/2, an additional 10% early withdrawal penalty may apply.

It's usually recommended to consider other options for meeting financial needs before resorting to a hardship withdrawal, because of its potential to significantly impact your long-term retirement savings.

An "In-service Withdrawal" in the context of the 401k industry is a provision that allows an employee to take a withdrawal from their 401k account while still employed with the company. This is different from typical withdrawals that are allowed after an employee has left the company, retired, or reached a certain age (typically 59.5 years).

The specific rules regarding in-service withdrawals can vary depending on the details of the company's 401k plan. Some plans may allow for in-service withdrawals only after a certain age, such as 59.5 or 55. Other plans may allow in-service withdrawals for specific reasons, such as financial hardship or for the purchase of a first home.

It's important to note that in-service withdrawals could be subject to income taxes and potentially an additional 10% early withdrawal penalty if the individual is under 59.5 years old. Additionally, taking an in-service withdrawal reduces the amount of money that can grow tax-deferred in the 401k, which can have a substantial impact on long-term retirement savings. As such, in-service withdrawals are generally recommended only in specific situations and after careful consideration.

Investment options in the context of the 401(k) industry refer to the variety of asset classes that participants can choose to invest their retirement savings in through their 401(k) plan. This selection typically includes a range of investment vehicles such as:

1. Stock Mutual Funds: These are funds that invest in the shares of different companies. They can range from aggressive growth funds to value-oriented funds.
2. Bond Mutual Funds: These funds invest in government, municipal, and corporate debt, offering regular interest payments and return of principal at maturity.
3. Money Market Funds: These are low-risk funds that invest in high-quality, short-term debt securities and cash equivalents.
4. Target-Date Funds: These funds automatically adjust the risk profile (the balance of stocks, bonds, and other investments) based on a specific retirement date. As the target date approaches, the fund gradually shifts towards more conservative investments.
5. Balanced Funds or Asset Allocation Funds: These funds invest in a mix of stocks and bonds aiming to strike a balance between growth and income.
6. Index Funds: These funds aim to replicate the performance of a specific market index, like the S&P 500.
7. International or Global Funds: These funds invest in non-U.S. companies, providing diversification across different economies.
8. Sector Funds: These funds invest in a specific sector of the economy such as technology, healthcare, etc.
9. Company Stock: Some employers offer the option to invest in the company's own stock.

The specific investment options available in a 401(k) plan can vary widely from one employer to another, as the selection is often determined by the plan administrator or provider. It's important for each participant to understand the risks, costs, and potential returns of each option and make selections that align with their own risk tolerance, investment goals, and time horizon.