What’s an 801(k)? And Why Should I Care?

The following post comes from Nicholas Pell at partner site Mintlife.

The Internet is abuzz with stories about 801(k) plans. Banner ads talk about the “best kept secret” in investment strategies. But 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) plan.

What’s an 801(k)?

The simple answer is that there’s no such thing as an official 801(k). 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 a made-up term. Unlike a 401(k), an 801(k) isn’t a tax-advantaged retirement plan offered by employers.

In fact, more often than not, an 801(k) plan goes by some other name, which is important to keep in mind when looking for one. Look for names like “Direct Purchase Plan,” “Direct Purchase and Sale Plan,” or “Dividend Reinvestment Plan.”

What these plans do is allow you to buy company stock directly from a corporation. Some of the biggest companies in the world offer 801(k) purchasing. (To see a partial list, go to this page of stock transfer agent Computershare’s website.) This allows you to save money on brokerage fees while also dipping your toe in the water when it comes to stock 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 don’t 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 cash.

Some plans even allow for scheduled automatic deductions from your bank account to purchase shares.

How you open, close, and alter an account varies widely from company to company, so make sure to carefully read the fine print before investing.

Pros and cons of 801(k) investing

It’s not all roses when it comes to investing in an 801(k), although 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 those with less money to get into investing.
• Stocks are sometimes 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 pick the stocks you buy. You’re on your own when it comes to researching where to invest.
• You might have to pay fees greater than you’d pay on a no-load mutual fund.

Making the decision

Because you’re investing in the stock market, 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, this is a great way to start.

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.