Employer Sponsored Retirement Plans
Retirement benefits are an important part of any workers’ employment because of the ability to save for retirement on a tax advantaged basis. Contributions can be provided by the employer wholly, in part, or by the employee. Up until 30 or so years ago, most companies provided a pension program whereas an employee that worked a certain number of years (e.g., 30) was able to receive a monthly/annual stipend the rest of their lives. The U.S. federal government and members of the U.S. military have pension-type programs. Unfortunately, given the rising costs and requirements of funding (as recently imposed by the Pension Protection Act), many employers are giving up on pension plans in favor of “defined contribution” plans, where the employee makes the investment decision (and the employee ultimately bears the financial/investment risk). Even with all of the ‘help’ provided, many employees do not understand the basic of investing and will not earn the returns that professional pension investment managers are able to achieve.
Depending on your employer, you may be provided the following defined contribution plan: 401(a), 401(k), 403(b), 403(b)(7), 457, or TSP. The main benefit of these plans is the tax advantage on contributions and interest. Contributions are not subject to federal taxes, thus lowering the employee’s overall tax liability (and increasing take-home pay as opposed to investing after tax monies). Withdrawals that are made after age 59½ (55 for the 401a) are subject to federal and state taxes, but the employee may be in a lower tax bracket than when they were working. Note that withdrawals before age 59½ are subject to an additional 10% penalty tax. The other advantage is that contributions are deducted from the employee’s paycheck.
- The 401(a) is funded by employee or employer contributions and is intended to serve as a replacement to a pension program. Contributions are exempt from Social Security and Medicare taxes (also known as “FICA”), which provides the employer an extra incentive to provide this plan. Employees utilize a broker to make the investments, either through mutual funds or stocks.
- 401(k)’s are the preeminent employer-sponsored retirement plan for private employers. Employee contributions may be matched from the employer, as an incentive for participation. For example, if the employer provides a $1 for $1 match up to 6%, then for every dollar of employee contribution the employer will add a dollar, up to 6 percent of the employee’s contribution. This provides the employee with an immediate 100% on their investment! Investments are normally made through a mutual fund company (e.g., Vanguard, Fidelity).
- The 403(b) is normally provided only to employees of educational institutions (e.g., colleges and universities), local/state governments (e.g., public schools), and churches. Investments are made directly with life insurance companies in the forms of fixed or variable annuities, which act just like mutual funds. The plans include a death benefit feature, for an additional ‘mortality and expense’ fee, which provides the employee a guaranteed amount of investment; most plans will provide the amount of contributions paid in to date, even if the account has declined in value. In addition, 403(b) participants have access to licensed retirement specialists that can provide investment advice.
- 457 plans are provided to the same group as 403(b) and have the same features and benefits. Some employers provide access to both a 457 plan and 403(b) plan, so the employee can be in both at one time. The 457 plan provides a unique benefit in that withdrawals made before age 59½ are not subject to the 10% penalty tax.
- The Thrift Savings Program (TSP) is available to federal governmental employees, and military personnel. The TSP program only provides six funds: G (governmental securities), F (fixed income), C (common stock index), S (small cap index), I (international stock index), and L (lifecycle/target type: income, 2010, 2020, 2030, 2040).
In 2018, the maximum that the employer and employee can contribute to an employer-sponsored retirement plan is $55,000. The maximum amount that an employee can contribute is $18,500, unless they are over 50, which they can contribute an additional $6,000 (called the “catch-up” contribution). Employers that provide matching contributions increase the total investment over time. Note that employees that have access to both a 403(b)/403(b)(7) and 457 can have separate contribution limits – essentially double-dipping.
Employers can also create other types of defined benefit and defined contribution plans: a simplified employee pension (SEP) account, SIMPLE plans, or Keogh plans (for self-employed). All have similar benefits and designs as the other employer-sponsored retirement plans.