What Is an 801(k)?
In a nutshell, 801(k) plans allow you to buy company stock directly from a corporation.
The Internet is abuzz with stories about 801(k ) plans. Banner ads talk about the “best kept secret” in investment strategies. Often, these same ads, and the blogs they link to, promise you everything under the moon with your 801(k ).
Savvy investors are doubtless skeptical of these claims. Others might not even know what an 801(k ) is or how it differs from the more traditional 401(k ) investment.
Anyone planning for their financial future should do extensive research on any investment strategy, particularly one such as an 801(k ), which makes lofty promises, is poorly understood and generally shrouded in mystery.
So, What Is an 801(k )?
The simple answer is that there’s no such thing as an 801(k ), per se. Whereas a 401(k ) refers to the section of tax law regulating retirement plans, an 801(k ) doesn’t exist in IRS code. It’s essentially a made up term.
Rather, there are specific types of investment instruments that have become collectively known as 801(k ) plans. More often than not, an 801(k) plan goes by some other name, which is important to keep in mind when looking around for 801(k )-type plans.
If you go shopping for 801(k ) plans, you’re probably going to find them under names like “Direct Purchase Plan,” “Direct Purchase and Sale Plan,” or “Dividend Reinvestment Plan.”
Ok. So, what are they then?
801(k ) plans allow you to buy company stock directly from the corporation. Some of the biggest companies in the world offer 801(k) purchasing. This allows you to save money on brokerage fees, while also dipping your toe in the waters with the big boys of investing.
Types of 801(k ) Investing
There are really two types of 801(k ) investment instruments. First, there are “Direct Purchase Plans” or “Direct Purchase and Sale Plans,” which are more or less the same thing. The second type is the “Dividend Reinvestment Plan.” These are known as “DPP” and “DRIP,” respectively.
The differences between the two are minor:
- DRIP is closed to people who do not already own at least some registered shares of stock in a corporation. Companies set the minimum threshold for stock ownership and DRIP participation. Oftentimes it can be as low as a single share.
- DPP allows for “open enrollment.” This lets you start investing in a company by purchasing stock directly, rather than going through a costly brokerage firm.
Both plans have one thing in common: You set them up to purchase more and more stock on the same advantageous terms a direct purchase offers. It’s up to you how much stock to purchase, and company regulations determine whether this additional stock can be purchased with your dividends or with cold, hard cash.
Some plans even allow for scheduled automatic deductions from your bank account to increase your investment over time.
How you open, close, and alter an account varies widely from company to company, so make sure to carefully read the fine print before you throw your hard-earned money into the market.
Pros and Cons of 801(k ) Investing
It’s not all roses when it comes to investing in an 801(k ), though they can be an attractive alternative to people shaking their fist at the sky every time they have to pay a broker’s fee.
Some advantages include:
- You can invest less than a broker might require, allowing lower-income families to get into investing.
- Stocks are often offered at a discounted price.
- Companies sometimes allow for the purchase of fractional stock. If you can’t afford a whole share, why not buy half of one?
- Did we mention that you won’t pay broker’s fees?
However, there are some potential pitfalls with 801(k ) investing:
- No one is going to help you. You know all the stuff your broker does? (Probably not.) You’re now doing that yourself.
- You might have to pay fees that are greater than you’d pay on a no-load mutual fund.
Making the Decision
An 801(k ) might not be the safest investment instrument in the world, but it can be fun and profitable. If you’ve always wanted to try your hand at the market, why not dip your toe in waters of an 801(k )?
As long as you don’t invest any more than you can afford to lose, it might be worth experimenting with this kind of investment. You might even find out that you have a knack for the game.
Editor's Note: This article by Nicholas Pell was originally published on MintLife.
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