It’s an unfortunate gotcha for the young person who’s learned about the power of starting to invest early for retirement, but in fact it’s true, companies may elect to restrict enrollment in their 401ks to employees over age 21. In general, 401ks are highly regulated at the federal level by ERISA (The Employee Retirement Income Security Act of 1974). For the most part, these regulations are very much a good thing, even when they may seem annoying.
The rules around 401ks strive to protect employees from malfeasance on the part of the employer or plan administrator with strict penalties for violations. For instance, if you elect to defer a certain amount to your 401k and the plan fails to execute your deferral, your employer may be required to make a contribute to the plan on your behalf of the half amount you elected that failed to be deferred (https://www.irs.gov/retirement-plans/fixing-common-plan-mistakes-correcting-a-failure-to-effect-employee-deferral-elections). So pay attention, and if something seems like it’s been implemented incorrectly, take the time to do some investigation and follow-up. If you’re sure they did something wrong and HR denies it, escalate to your legal department. HR does not know tax law.
So back to the situation for under-21 employees. In these cases, some young people raring to get started saving for retirement may be shocked to discover their 401k didn’t allow one to enroll if they’re under 21. Usually 401ks must strive to treat all employees the same, but this is an exception. And why is that? Because it can result in significant cost savings, which hopefully gets passed on in the form of lower fees to employees.
When an employer opts to open a 401k, they contract with a 401k provider, which will then set fees based primarily on the number of people and amount invested in the plan. Then HR runs the plan for employees. If you’ve got an employer I’d consider “good”, hopefully that plan has provisions like auto-enrollment of new employees, setting them up in a good default fund like an Target Date Fund, a contribution match that doesn’t have a vesting requirement, and allows you to leave your 401k there if you choose to after separating from service without excessive fees.
But each of those benefits comes with a cost. There’s overhead to having more enrollees, overhead to anto-enrolling every employee, cost to providing a match, especially without vesting, and cost to letting past employees stay in the plan. So if you’re an employer that hires a lot of part-time employees, or seasonal employees, or interns, those people jumping in and out of your 401k plan are going to increase costs for everyone, and disproportionately to the amount of use they get out of the plan.
In fact, one pattern I see among people who did have access to these “good” 401ks when they were under 21 is they were auto-enrolled unknowingly. They were initially unhappy, but accepting once they realized where part of their paycheck was going. However when they leave the employer after 3-12 months, then are below the minimum balance to stay in the plan so the amount is disbursed, and then they don’t know what to do with it and put it in their checking account and are hit with taxes and an early withdrawal penalty come tax time.
So while the young people out there chomping at the bit to get started on saving for retirement are near and dear to my heart, this isn’t the worst restriction ever, and it may save you money in the form of lower 401k fees for all those post-21 years to come.
Fear not, though, you’re not out of retirement savings options! If you to happen to be in the comfortable position to be able to start saving for retirement while young (meaning you have enough saved to cover a couple months’ expenses and no debt over 5% or so) and you can’t access or don’t have an employer who offers a 401k, you can still fund an IRA. Unless you are working full time and/or an extremely well-compensated young person, you probably want to be looking at a Roth IRA.
Of course the issue you’ll run into with an IRA is you can only contribution $6000/year. And no, you can’t go back and contribute for prior unused years unless it’s before tax day when you have to file for that year.
So if you have even more than that $6000/year you want to invest for the long-term, you can consider making a taxable investing account for the time being and planning to use money from there to subsidize your spending while you sink the IRS limit (currently $19k/year) into your 401k as soon as you turn 21.