Employer Plans, Part 1Employer Plans,
Part 1

As part of your employment benefits package, some employers provide a way for you to save for and invest in your retirement. The money you save or invest in employer retirement plans accumulates tax-free until you retire and begin withdrawing money from the plan.

For some employer plans, saving and investing in them can lower your taxable income. Each type of employer plan is presented below.

Defined Benefits Plans

In years past, many companies paid the costs of pension plans for their workers under a program called a “defined benefit plan.” This retirement plan pays you a fixed amount (the defined benefit) each month during retirement. How much you receive depends on how long you worked for the company and how much you earned before you retired.

Although defined benefit plans are not as common in the private sector any more, many employees who work in the public sector (federal, state, or local governments) still receive “defined benefits” at retirement. However, even those plans are changing for some public sector employees, including newer ones who are being enrolled in defined contribution plans.

Defined Contribution Plans

Today, as part of an employee’s benefit package, many companies offer a “defined contribution” plan instead. For this type of retirement plan, you contribute a fixed amount (the defined contribution), usually a percentage of your income. Employers typically offer retirement plan workshops for employees so they can learn:

  • How the plans work.
  • The tax benefits they offer.
  • How to transfer funds after a change of jobs.
  • How to begin withdrawing the funds at retirement.

Employers will also inform employees on the types of investments they can make in their defined contribution plans, and the level of risk associated with each investment. Which investment(s) employees choose in their defined contribution plans is left to each employee. That way, employees can choose investments with risk levels they are comfortable with.

Types of Defined Contribution Plans

Three common types of defined contribution plans you may hear references to are:

  • 401(k) (For-profit companies)
  • 403(b) (Non-profit organizations)
  • SIMPLE (Savings Incentive Match Plan for Employees)

Contribution Amounts

Employees may choose what amount they want to contribute to their retirement plans, usually one to six percent of their income. For example, if you earn $60,000 and contribute five percent of your income to a defined contribution plan, you will save $3,000 each year. There are limits to the amount you can contribute each year. For example, with SIMPLE, you can contribute up to $6,000 each year.

Matching Contributions

Some employers provide the employee benefit of matching your retirement plan contributions. While employer matching contributions are regulated by the Employee Retirement Income Security Act of 1974 (ERISA), each employer is able to decide by how much it will match employee retirement plan contributions. Typically, employers base their matching contributions on a certain percentage of your:

  • Income. For example, your employer may base matching contributions on 50 percent of your income. From the income example above of $60,000, this means your employer’s matching contributions would be based on $30,000.
  • Contributions. For example, your employer may base matching contributions on one percent of your contributions. From the contribution percentage example above of five percent, or $3,000, this means your employer’s matching contribution would be based on one percent, or $600. 

If you take into account that your employer’s matching is based on only 50 percent of your income, this means your employer’s matching contribution would be $300, or one percent of $30,000.

(see Hilary Z. Simpson. “Compensation and Working Conditions--“How Does Your 401(k) Match Up?” Bureau of Labor Statistics. May 26, 2010)

Employers are also able at their discretion to suspend or reduce matching employee retirement plan contributions, for example, in challenging economic times. But for any matching your employer does provide, at any level, consider it a valuable employee benefit. It is like getting free money.

Vesting

When it comes to your retirement plan, vesting means “ownership.” Your contributions to an employee retirement plan are always vested (see IRS.gov. “Retirement Topics—Vesting.” Page last reviewed August 5, 2010. Retrieved from http://www.irs.gov/retirement/participant/article/0,,id=211324,00.html on November 19, 2010.), meaning that you always “own” them—you never have to give them back. Should you change jobs, you can transfer the amount of your contributions from your “old” retirement plan to a new one or directly to a rollover IRA.

Sometimes employers’ contributions may become immediately vested. This means that you own them as soon as you start receiving them. In other cases, employer contributions may follow a phased-in vesting period based on your years of service. For example, you may own, or become vested in, a certain percentage of your employer contributions after one year of work, a higher percentage after two years of work, and so on until you own, or become fully vested in, all of your employer’s matching contributions.

Vesting periods for employer contributions vary at each company, but they generally last three to six years (see IRS.gov. “The Fix Is In: Common Plan Mistakes - Vesting Errors in Defined Contribution Plans” Retrieved http://www.irs.gov/retirement/sponsor/article/0,,id=144502,00.html from on November 19, 2010.) and have a phased-in ownership schedule. If you were to change jobs before the full vesting period is over, you would be able to transfer only the vested employer contributions (the amount you “own”) to a new retirement plan. Check with your employee benefits staff to find out how long your company’s vesting period is.

 

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