401(k) plans are pension savings options that help workers save tax-deferred money towards their eventual retirement.

These retirement plans are intended to supplement a pensioner’s Social Security and other pension funds. Most people contribute to a 401(k) plan through their employer, though privately held 401(k) plans are available on the market as well. Many employees prefer to contribute to their 401(k) plan through their employer when that employer offers to partially or even completely match any invested funds.

A 401(k) plan may not be the best retirement investment strategy for everyone. Especially for self-employed individuals and those working for employers who do not offer an attractive retirement plan, other pension-building strategies may be able to get investors a higher rate of return than comparable investments into an independent 401(k). There are several federal laws and policies restricting how 401(k) plans can be structured and how investors can access those funds. Keep reading to discover everything you need to know to understand the ins and outs of 401(k) retirement plans.

Common Types of 401(k) Plans

Employers can choose to offer their workers multiple types of 401(k) plan options, each with its own pros and cons. The most common 401(k) plans offered by employers include Traditional, Roth, Safe Harbor and SIMPLE investment plans. Each type of plan is governed by its own set of rules and regulations and therefore a better fit for some groups of investors over others. For workers, understanding how these different 401(k) plans work and especially which of these options an employer offers is important to being able to maximize their return on their investment.

Traditional 401(k) Retirement Plans 

Traditional 401(k) plans are offered by many big and small employers around the country. This type of retirement plan requires employers to make a regular blanket contribution to all workers involved in the fund or specific matching contributions to each worker’s individual investment. Traditional plans must include some sort of nondiscrimination requirement protecting employees from receiving unequal contributions from an employer. All employer and employee contributions under traditional 401(k) plans are made at a pre-tax rate. Workers can withdraw their funds from this account before retirement, however these funds will be taxed at the time of withdrawal.  

Roth 401(k) Pension Plans 

Roth 401(k) plans are similar in structure to traditional 401(k) plans, with one important difference. Roth 401(k) pension plans accept contributions on a post-tax basis, meaning all funds in the account have already been taxed prior to investment. This requirement holds true for funds invested by both employees and their matching employers. Funds can be withdrawn from a Roth retirement plan without incurring any more tax charges.

Safe Harbor 401(k) Retirement Plans 

Safe Harbor 401(k) plans offer a more limited pension savings strategy to employees. Like Traditional 401(k) plans, Safe Harbor investment funds accept pre-tax contributions from employers and employees on a set schedule. However, employers can set additional requirements for participation in a Safe Harbor plan. Many employers who use this savings strategy do not allow employees to access these funds until they have become fully vested in the company, for example, usually after remaining at the company for a set period of time or meeting other specified milestones. Safe Harbor 401(k) plans are also not required to include any guarantees of nondiscrimination between employees.

SIMPLE 401(k) Pension Plans 

Some small employers offer SIMPLE 401(k) plans to their employees. SIMPLE pension plans are similar to Safe Harbor retirement strategies in that they allow employers to set a number of conditions on when an employee can access his or her funds and employers are not required to include nondiscrimination protection. Many companies offering SIMPLE 401(k) plans require employees to be fully vested in the company as well.

Restrictions on 401(k) Saving Plans

There are several federal regulations governing how retirement plans can be structured, managed and invested in. The Internal Revenue Services (IRS) sets national standards for and restrictions on 401(k) plans for employers across the country. Depending on the type of plan being offered, employers can than add further restrictions or conditions to any acceptable retirement plan. The IRS decides how much of an employee’s wages can be directed towards a qualifying 401(k) account, known as salary deferral contributions. The amount of an allowed salary deferral is calculated as a percentage of the worker’s overall earnings in an effort to cap how much he or she can invest into the plan at once. For many employers, this important restriction makes it possible to make regular matching contributions to employee investments. Some employers also limit how much an employee can add to a qualifying 401(k) account based on the employee’s age.

The basic regulations that manage how employers must make contributions to their employee’s retirement plans are set by the IRS, but most plans are also limited by several other restrictions as well. Many companies have their own caps for matching programs, for example. Companies that offer their employee’s Safe Harbor or SIMPLE plans can use their own definition of what it means to be fully vested in the company, essentially setting their own limitations for employer contributions and employee access to funds. Generous employer matching programs provide employees with 100% matching contributions, while other max out at 50% or much less. In some cases, employers will only match up to a certain level of employee contributions. Employers that use annual nondiscrimination tests in their fund plans help ensure that all of their employees can build a strong retirement strategy.

Enrollment in Employment-based 401(k) Pension Plans

Employees who are joining a company for the first time should make sure to learn about how their new employer handles its employees’ retirement plans. Some companies automatically enroll employees in their 401(k) when completing all of the employee’s other onboarding paperwork. Other companies require employees to take special steps to learn about their program and sign up to participate. It is important to note that even in companies that automatically enroll new employees, workers always have the choice to opt out of participation. Participation in a company 401(k) plan should not be required by any employer.

If you are enrolled in a valid 401(k) plan with your current provider but will soon be changing companies, you can usually transfer your current fund to your new employer. Because 401(k) plans are intended to help workers save for their retirement throughout their lifetime, the IRS makes it easy to keep the same investment account throughout career changes. Workers will have to take a few steps to make sure their account is correctly transferred to their new company, depending on the type of 401(k) fund an employee currently has and the type he or she will be switching to. If transferring the fund is not ideal, workers usually have the option of withdrawing their funds and then investing them in another type of account.