What Is The Pupose of a 401k Plan?
This question is best answered from multiple perspectives:
On a macro-level, the original purpose of 401k plans was to be the final leg of the ideal “three-legged” retirement funding strategy. Under this ideal, workers would have guaranteed retirement income from two sources (Social Security and a traditional company pension plan) and these would be supplemented (to the extent deemed necesary by the worker) with voluntary savings built-up over the course of a career in a 401k. Since 401k participants were presumed to have Social Security and DB pensions managed on their behalf, they were given wide latitude to manage investments, contributions and other aspects of their 401k’s.
- The present-day macro-level pupose of 401k plans is to serve as the primary retirement funding vehicle for private sector workers. Over the past 25 years, 401k’s have evolved from their original supplemental role to a new role of elevated importance. According to the Center for Retirement Research at Boston College, 63% of workers with pension coverage today have a 401k as their primary or only plan. The 2008-09 market downturn has generated much discussion as to whether 401k’s are up to the task as serving as the main retirement funding vehicle for Americans.
- On a micro-level, the purpose of a 401k plan from the employee’s (plan participant) perspective is to serve as a tax-advantaged savings vehicle for retirement – i.e. the best available option available for building a retirement nestegg. Employees elect to have their employer contribute a portion of the employee’s cash wages to a 401 plan on a pre-tax basis. These deferred wages (elective deferrals) are not subject to federal income tax withholding at the time of deferral, and they are not reflected as taxable income on the employee’s Form 1040, U.S. Individual Income Tax Return.
- The purpose of a 401k plan from the micro-level vantagepoint of the employer (plan sponsor) is to be a tool to help attract and retain qulified employees. However, many employer’s do not feel the need to offer this type of benefit to attract qualified employees and do not offer 401k plans. Employers that do offer a 401k retirement plan have wide discretion in setting plan features. As a result, 401k plans vary widely in features from sponsor to sponsor, ranging from bare bones 401k’s to rich plans with large employer matching contributions and other attractive features.