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12 Important Terms For 401k Beginners to Know Thumbnail

12 Important Terms For 401k Beginners to Know

If you're beginner or feel like a beginner when it comes to your 401k, you're not alone. One of the challenges that puts 401k beginners off is the odd terminology. The 401k application at work probably didn't come with an easy to read glossary. Fortunately, we've put together some definitions written in plain English to help you get started with your 401k and saving for retirement


Why is it called a 401k?

First, let's talk about what might be the most important one: the 401k itself! What does the "k" stand for in 401k? Nothing. These types of retirement plans come were created from section 401(k) of the Internal Revenue Code or the federal tax code. It's a terrible name that has never changed. Don't expect it to anytime soon. 


Important Terms for 401k Beginners to Know:


Contribution

A contribution is money you, an employee and participant in the 401k, put into your 401k account.

 

Deferral Rate

Sometimes called an elective deferral or salary deferral

When you sign up to participate in a 401k plan, one of the decisions you’ll make is on how much money from each paycheck to go into your retirement savings. The deferral rate is a percentage you choose as part of getting started. The deferral rate is not locked in and can be changed at your discretion.

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Enroll

Sometimes called enrollment or employee enrollment

When you get started with a 401k, you have to enroll just like other benefits at work. Some 401ks offer “automatic enrollment.” This means new employees are assumed to be enrolled by HR and you have to raise your hand or “opt out” to not participate. You’ll want to check either way. Enrollment is generally easy with most providers now offering online or mobile enrollment that takes just a few minutes.

 

 

Match

Sometime called an employer match or matching contribution

A 401k match is when your employer puts in money alongside what you put in. It’s called a match because many employers want to encourage you to contribute. Not all employers or 401ks offer a match, but the benefit can be very valuable. For example, an employer could decide to match dollar for dollar up to 2%. This means someone who contributes 2% on their own is doubling their money right away.

 

Plan Rules

Each employer has rules specific to their 401k. Your employer is no different. You will see references to certain things you are or are not allowed to do that mention plan rules. Your employer has the ability, within some limits, to make written rules about what you can do with your 401k. You have the right to see these rules at any time. Most providers give you online access to rules specific to your plan.

 

Roth

Sometime called a Roth 401k or Roth option

Some 401ks offer a “Roth” 401k feature. The distinction from a regular or “traditional” 401k has to do with taxes. With a traditional 401k, you save money you have not yet paid taxes on, but will pay taxes on when you take money out later in retirement. A Roth 401k does the opposite. In a Roth 401k you take money you already paid taxes on but when you take money out later in retirement will not owe taxes.

 

Expense Ratio

Most 401ks offer multiple mutual funds as choices for where you can direct your savings. Mutual funds have ongoing expenses called an expense ratio. This is a percentage the mutual fund charges investors. Because the fee is subtracted from what your investments earn, it’s important to minimize this fee where possible. Each choice your 401k provider offers you will likely have a different expense ratio associated with the investment option.

 

Loads

Sometimes called Front-end loads, back-end loads, or Sales charges

Some 401ks include mutual funds that charge loads. A load is a commission or sales incentive you pay when you buy a certain type of mutual fund. The most common occurrence is a load when buying, although many 401ks eschew investment choices with loads. You may not have a choice, but if you do, avoid sales loads. If your 401k has these types of fees, respectively ask your HR department to seek better options. Loads are garbage.

 

Mutual Fund

Sometimes called a fund or fund choice

A mutual fund is a collection or “pool” of investments. Instead of you buying hundreds or thousands of investments, the mutual fund does so on your behalf. Mutual funds often hold investments like stocks or bonds. 401ks can all be different, but the overwhelming majority of 401ks offer mutual funds as investment options.

 

Roth

Sometime called a Roth 401k or Roth option

Some 401ks offer a “Roth” 401k feature. The distinction from a regular or “traditional” 401k has to do with taxes. With a traditional 401k, you save money you have not yet paid taxes on, but will pay taxes on when you take money out later in retirement. A Roth 401k does the opposite. In a Roth 401k you take money you already paid taxes on but when you take money out later in retirement will not owe taxes.

 

 

Target Date Fund

Sometimes called a target fund, lifestyle fund, or life cycle fund

Target date funds are a type of mutual fund. If a retirement saver wants to put together a diversified 401k, it usually requires several mutual funds and some work. Target funds are meant to be a “packaged solution” that seeks to offer these same benefits with one choice. The funds also, generally, adjust over time as you approach retirement. Target date fund usually have a year (your approximate retirement timeframe) to help you gauge what might be an appropriate choice. For many 401k funds, a target date fund is the default choice if you don’t choose otherwise.


Vesting

To encourage employee retention, some employers institute a policy for their 401k to encourage you to stay called vesting. Vesting means that money your employer puts in may not be full yours until you have a set period of time at the company. This could gradual over a few years or you could get the full benefit all at once after a few years. Note this only applies to money your employer puts in and not to what you put in on your own.



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