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I'm considering a few job offers for post-college, and I'm wondering how this (Roth) 401(k) plan stacks up against the average offering:

  • After one year of service, [Company] will:
    • Contribute 1% to employee's account regardless of their savings levels
    • Match 100% of the first 5% and matched funds will be immediately vested
  • Loan provision is available

I'm new to the world of finance really. What does "loan provision is available" mean?

  • @c.ross doesn't the title change limit the scope of the question more than the OP implied? Seemed he wanted a comment on all three aspects mentioned. The loan was a small portion. – JoeTaxpayer Sep 3 '12 at 15:51
  • @JoeTaxpayer I think what the asker wanted was unclear. The only clear question is the last bit, so I went with that. I also think "compare my package at unspecified job to some unspecified 'market'" isn't really answerable. Bob, please clarify for us what you're looking for. – C. Ross Sep 3 '12 at 16:54
  • I can see that. I read "how does this compare to average?" it's for we experts to know what average is. – JoeTaxpayer Sep 3 '12 at 18:16
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Congratulations on the job offer!

That type of matching sounds good if you plan to stay at a company for more than a year. My experience has been that 401k matching can range from 2% up to 8% for your typical starting job, so a total of 6% is good. You would definitely want to contribute at least 5% to take advantage of the "Free" money.

Loan provision could mean that loans from 401k are allowed. I did some research and found that not all company 401ks allow for you to take a loan out of your 401k. Typically this is bad practice since you are robbing your 401k of it's major advantage - tax free compound interest. Source

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401K accounts, both regular and Roth, generally have loans available. There are maximum amounts that are based on federal limits, and your balance in the program. These rules also determine the amount of time you have to repay the loan, and what happens if you quit or are fired while the loan is outstanding. In these loan programs the loan comes from your 401K funds.

Regarding matching funds. This plan is not atypical. Some match right away, some make you wait. Some put in X percent regardless of what you contribute. Some make you opt out, others make you opt in. Some will direct their automatic amounts to a specific fund, unless you tell them otherwise.

The big plus for the fund you describe is the immediate vesting. Some companies will match your investments but then only partially vest the funds. They don't want to put a bunch of matching funds into your account, and then have you leave. So they say that if you leave before 5 years is up, they will not let you keep all the funds. If you leave after 2 years you keep 25%, if you leave after 3 years you keep 50%...

The fact they immediately vest is a very generous plan.

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As Mhoran answered, typical match, but some have no match at all, so not bad.

The loan provision means you can borrow up to $50k or 50% of your balance, whichever is less. 5 year payback for any loan, but a 10 year payback for a home purchase. I am on the side of "don't do it" but finance is personal, and in some situations it does make sense.

The elephant in this room is the expenses within the 401(k). Simply put, a high enough expense will wipe out any benefit from tax deferral. If you are in this situation, I recommend depositing to the match, but not a cent more.

Last, do they offer a Roth 401(k) option? There's a high probability you will never be in as low a tax bracket as the next few years, now's the time to focus on the Roth deposits, if not in the 401(k), then in an IRA.

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Basically, a 401(k) can have what is called a "loan", but is more properly a "structured withdrawal and repayment agreement". This allows you to access your nest egg to pay for unforeseen expenses, without having to actually cash it out and pay the 10% penalty plus taxes.

You can get up to half of your current savings, with an absolute cap of $50k, minus the balance of any other loan outstanding. While there is a balance outstanding, you must make regular scheduled payments. The agreement does include an interest rate, but basically that interest money goes into your account. The downside of a 401(k) loan is the inflexibility; you must pay the scheduled amount, and you also have to keep the job for which you're paying into the 401(k); if you quit or are fired, the balance of the loan must usually be paid in 60 days, or else the financial institution will consider the unpaid balance a "withdrawal" and notify the IRS to that effect.

Now, with a Roth account, it works a little differently. Basically, contributions to any Roth account (IRA or 401(k)) are post-tax. But, that means the money's now yours; there is no penalty or additional taxes levied on any amount you cash out. So, a loan basically just provides structure; you withdraw, then pay back under structured terms. But, if you need a little cash for a good reason, it's usually better just to cash out some of the principal of a Roth account and then be disciplined enough to pay back into it.

  • I've never seen or heard of a loan from a 401(k) getting reported to credit bureaus, or in any way becoming part of one's credit history. Next, one can take a loan from a 401(k) but can't simply "withdraw" funds. Last, the account gets the interest charged, there's no bank making the loan, you are borrowing your own money, and pay your account the rate you pay. Do you any reference to back up any of your answer? – JoeTaxpayer Sep 6 '12 at 0:30
  • @JoeTaxpayer - First, my wife took out a 401(k) loan for some expenses before we were married, and I can tell you that, indeed, those payments are reported to the credit bureaus. Second, yes you can "cash out" of a 401(k) early (before 59.5 years old); you'll pay a 10% penalty to the financial institution, plus taxes on the withdrawn amount. However, the interest you pay goes directly into your account, so I will edit that. – KeithS Sep 10 '12 at 14:56
  • Not to split hairs, but "never seen or heard" means literally that, that I am unaware. A withdrawal is permitted for hardship, not on a whim. The OP is talking 401(k) vs Roth 401(k). I think you are confusing this with a Roth IRA. Again, "I think", I don't know for sure. – JoeTaxpayer Sep 11 '12 at 0:04

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