Glossary of Terms

We’ve put together a list of 401(k) terms and their definitions to better help you understand the sometimes confusing world of 401(k).

12(b)1 Fees:
A type of mutual fund fee that is often used to compensate brokers for selling the fund. Typically the fee ranges from .25-1%, and is included in the fund’s expense ratio.

3(21) Investment Adviser:
Someone who provides an investment recommendation to a 401(k) plan to the plan’s sponsor. As a “fiduciary” under Section 3(21) of ERISA, a 3(21) Investment Advisor shares responsibility, but the plan sponsor retains responsibility for deciding whether to accept or reject the recommendation.

3(38) Investment Manager:
A registered investment adviser or other qualified professional authorized to make investment decisions on behalf of a 401(k) plan. A plan sponsor is responsible for selecting and monitoring the 3(38) Investment Manager, but the plan sponsor is relieved of responsibility for making the investment decisions.

401(k) Plan:
An IRS-qualified savings plan that is sponsored by an employer to allow employees to save for retirement directly from their paycheck on a tax-deferred basis.

401(k) Plan Sponsor:
A designated party—typically the employer—who sponsors a 401(k) plan for the benefit of the plan participants—typically its employees.

Administrator:
A service provider for a 401(k) plan who maintains the plan document, performs annual compliance testing, and prepares annual IRS filings like Form 5500. The administrator may be the same party as the record keeper. If the administrator is not the same party as the record keeper, they might be called a Third Party Administrator.

Asset Allocation:
The proportioning of stocks and bonds within a portfolio to balance risk and reward to target an individual’s goals.

Auto-Enrollment:
A feature that can be added to a 401(k) plan that automatically enrolls employees in the plan when they become eligible, unless they opt out. Without this feature, employees must actively “opt in” in order to participate in the plan. Auto-Enrollment can lead to increased employee participation rates.

Auto-Escalation:
A feature that can be added to a 401(k) plan to allow automatic increases in a participant’s deferral rate over time.

Blackout Period:
The period of time that a 401(k) plan goes offline during a service provider transition. Participants are not able to make any adjustments to their accounts during this time.

Catch-Up Contribution:
An amount ($6,000 for 2017) that participants age 50 or older are able to contribute to their 401(k), in addition to the standard contribution limit ($18,000 for 2017).

Collective Funds:
An investment vehicle that functions like a mutual fund, but it is sponsored by a bank and is only available to qualified retirement plans—like 401(k) plans. They are also referred to as collective investment trusts (CITs) or collective investment funds (CIFs).

Compliance Testing:
Annual tests required by the Department of Labor (DOL) to make sure the plan does not discriminate in favor of highly compensated employees.

Contribution Limits:
Annual limits set by the IRS on the amount that can be contributed to a 401(k) plan. For 2017, the maximum an individual can contribute is $18,000 (plus $6,000 in catch up for those 50 and older). The total that can be contributed on behalf of an individual (individual contribution + employer contribution) is $54,000 (plus $6,000 in catch up for those 50 and older).

Deferral Rate:
The average percentage of income that participating employees contribute to the plan.

Defined Benefit Plan:
There are 2 general types of IRS-qualified retirement plans, Defined Contribution Plans and Defined Benefit Plans. Defined Benefit Plans require the employer to contribute on behalf of the employees in order to provide a defined benefit to the employees at retirement. Typically the retirement benefit is based on salary and length of service. Types of Defined Benefit Plans include Traditional Pension Plans and Cash Balance Plans.

Defined Contribution Plan:
There are 2 general types of IRS-qualified retirement plans, Defined Contribution Plans and Defined Benefit Plans. Defined Contribution Plans allow both the employer and the employee to contribute, but no employer contributions are required. Unlike a Defined Benefit Plan (which defines the benefit at retirement), Defined Contribution Plans specify the contribution going into the plan today. The most common type of Defined Contribution Plan is a 401(k).

Department of Labor (DOL):
The federal agency responsible for work-related benefits and rights, including administering ERISA.

Diversification:
The concept of dividing assets among different types of investments in order to manage risk.

Employer Match:
A type of 401(k) employer contribution that allows the employer to provide a match on money employees contribute to the plan. This can be accomplished through various formulas, and can also be subject to vesting. It provides an incentive for employees to contribute to the plan.

ERISA:
The Employee Retirement Income Security Act of 1974, which is a federal law that governs private sector retirement plans, including 401(k) plans.

ERISA Plan Audit:
An examination of a 401(k) plan’s financial statements conducted by a certified public accountant. Plans with more than 100 participants are required to be audited annually.

Fiduciary:
A party (person or company) who makes decisions for a plan or gives investment advice to a plan, and legally must act solely in the interests of the plan and its participants.

Fiduciary Audit File:
A compilation of all documents a plan sponsor would need in the event of a plan audit. Can be maintained as a physical or electronic file.

Form 5500:
A compliance, research and disclosure tool for the Department of Labor. Every 401(k) must be file one annually in order to remain compliant.

Form ADV:
The form used by investment advisers to register with the Securities & Exchange Commission (SEC) and state securities authorities. Part 2 of Form ADV is where investment advisers disclose information about their firm, their business practices and their fees. Investment Advisers are required to deliver Part 2 of Form ADV to all clients and prospective clients.

Gap Analysis:
A comparison of how much income an individual is projected to have during retirement and projected financial needs during retirement. The gap between these two numbers helps individuals understand whether they are on track to achieve their retirement goals.

Highly Compensated Employee (HCE):
For 2017, any employee who:

  • Earned greater than $120,000 in gross compensation in 2016; or
  • Is a 5% (or greater) owner of the company; or
  • Is a direct family member (spouse, child, parent, grandparent) of a 5% (or greater) owner of the company

 

Mutual Fund:
A type of pooled investment vehicle regulated by the Securities and Exchange Commission. Investors’ money is collectively invested in other securities, like stocks or bonds.

Non-highly compensated employee (NHCE):
All employees who are not considered highly compensated.

Participation Rate:
The percentage rate at which eligible employees participate in a plan. Many plans use this as a metric to help understand how engaged their employees are in the plan. It is calculated by taking the number of employees participating in the plan divided by the total number of employees that are eligible to participate in the plan.

Plan Benchmark:
A process to help determine whether fees paid by plans are “reasonable.” Typically, this is done by comparing the fees paid by similarly sized plans receiving similar services.

Plan Document:
The document outlining all rules and features of a specific 401(k), including plan eligibility requirements, entry dates, types of allowable contributions and vesting schedules. Every plan has a plan document, and the plan manages the plan according to the plan document.

Profit Sharing:
A type of retirement plan employer contribution that provides the most flexibility to the employer. Annual contributions are made on a discretionary basis, which means that the employer can choose each year whether they want to contribute or not.

Qualified Default Investment Alternative (QDIA):
A plan’s default investment option that is used when a plan participant has not made an investment selection for their 401(k) assets.

Record Keeper:
A service provider for a 401(k) plan who keeps track of the different money sources in the plan, provides online support and participant statements. The record keeper may also perform administrative, custodial or trustee functions.

Request for Proposal (RFP):
A document issued by a plan sponsor asking service providers to respond with written proposals, enabling a formal comparison among multiple service providers.

Retirement Readiness:
The degree to which plan participants are on track to achieve their financial retirement goals.

Rollover:
The process of moving money from one qualified account to another. For example, you can roll an IRA into a 401(k) account.

Safe Harbor 401k:
A type of 401(k) employer contribution that eliminates the need for most annual compliance tests. If a 401(k) includes a Safe Harbor provision, the employer is required to make annual contributions on behalf of the employees: either a contribution of 3% of each employee’s compensation to every employee, or a 100% match on the first 3% of each employee’s contribution and 50% match of the next 2% of each employee’s contribution. Employer contributions are immediately 100% vested.

Securities:
Documents evidencing a right to receive a payment, either as an owner (for stocks) or as a creditor (with bonds). Securities can be bought, sold or traded.

Self-Directed Brokerage Account:
An option within a 401(k) plan that allows the participant to invest in funds, stocks or bonds outside of the plan’s investment lineup.

Target Date Fund:
A type of age-based investment vehicle. Target date funds are tied to a specific retirement date, and will automatically become more conservative in investment style as the targeted date approaches.

Vesting Schedule:
A schedule that outlines the rate at which employees get to keep the employer contributions made on their behalf in the 401(k) plan. Not all plans have vesting schedules. The maximum vesting schedule is a 6-year graded, which means that employees gradually become vested over a 6 year period of working for the company.