Everything You Need to Know About Employer-Sponsored Retirement Funds
It’s easy to have a narrow focus when it comes to considering the merits of a job offer. After all, the size of a paycheck and number of vacation days have the most immediate impact on your day-to-day life. But there are other aspects of a compensation package, like participation in an employer-sponsored retirement plan, which can provide a tremendous amount of value and set one job apart from the rest.
How Much is a Retirement Fund Worth?
Let’s consider two jobs, one with a higher salary and one with access to a 401(k). Job two offers easy access to a savings platform, the potential to save more thanks to higher contribution limits, and a savings match. Unless job one offers a salary that is significantly higher, and you are confident in your ability to grow your nest egg on your own, it’s easy to see the back-end benefit of going with job two.
But cashing in on this potentially significant financial benefit means understanding the basics and the differences between what employers offer. It could also mean being able to decipher between multiple plans offered by the same employer.
Understanding Retirement Plans
My previous employer offered a pension, 401(k), Roth 401(k), and 403(b). New to the world of retirement and personal finance, in general, I procrastinated. This procrastination meant I wasn’t saving or capitalizing on a 3% employer match for an entire year.
A little knowledge can go a long way. So whether you’re on the fence about a job offer, or you need to know more about your current employer’s retirement plan offerings, you’ve come to the right place.
Types of Plans
Retirement plans can be classified in several different ways, but they generally fit into one of two camps. They might also be a hybrid of both.
- Defined Benefit (DB): Plans pay out a “defined benefit” upon retirement, usually determined by factors like age, years of service, a pre-determined rate of return, and vesting schedule. Employers assume the risk with a DB plan.
- Defined Contribution (DC): The payout depends entirely on what you put in, what your employer matches, and your investment return. Employees assume the risk with a DC plan.
Here are a few types of plans you might have access to:
You might not know the term “defined benefit,” but you’ve probably heard of pensions. Most private sector employers have moved away from pensions that promise a certain payout upon retirement, but many public sector employers do still offer them. Public sector pensions are often funded in part by both employer and employee contributions and offer a lifetime benefit.
401(K) or 403(b)
Perhaps the most widely recognized type of retirement plan, 401(k)s and 403(b)s are both DC plans, meaning they are funded in large part by the employee. The biggest difference is the type of employer that offers them -- 401(k)s are offered by for-profit employers whereas 403(b)s are offered to teachers, nonprofits, hospitals, and religious groups.
This plan is offered to certain government and nonprofit employees and is also considered a DC plan. The difference between this plan and a traditional 401(k) lies primarily with contribution limits and how early withdrawals are treated.
Created to lessen the reporting duties for small employers, a SIMPLE IRA has an added benefit for employees: It requires employers to contribute on their behalf, even if the employee isn’t contributing. They also have higher contribution limits than traditional IRAs.
TSA (Thrift Savings Plan)
The Thrift Savings Plan is similar to a 401(k) but for federal employees and members of the military. This plan is known for having low fees and offers both a pre-tax and post-tax (Roth) plan option.
The Basics: Things You Should Consider With Every Plan
Retirement jargon can be confusing to say the least. But regardless of the type of plan you’re looking at, there are a few ways to boil it down to a few basics.
Contribution limits, or the amount you can contribute to a plan annually, vary from plan to plan and can change from year to year. For 2015 - 2017, 401(k), 403(b), TSA, and 457 plans are capped at $18,000 for employee contributions, but an employer can add a match to bring that total to $53,000. This is in sharp contrast to the $5,500 cap on IRAs, for instance.
Do you want to pay taxes on your savings now so you can avoid the bill in retirement? Or would you rather lower your taxable income now and pay taxes in retirement? If your employer offers Roth options (i.e. Roth 401(k)) and traditional options (i.e. 401(k)), this is an added benefit.
Because retirement plans are created with certain tax incentives to encourage saving, taking an early withdrawal usually comes with penalties. Early withdrawal is usually any money you take out of a plan before the age of 59 ½. If you take an early withdrawal from your 401(k) or 403(b), for instance, you will pay 10% of the amount taken in fees, plus that amount will be added to your taxable income for the year. On the other hand, 457 plans don’t come with withdrawal penalties, but the amount withdrawn will still be added to your taxable income.
If you want to keep your retirement accounts streamlined, rolling over funds from another account -- especially if you’re starting a new job -- can be a good idea. However, depending on tax treatment and plan structure, not all plans accept rollovers. (This chart can help.)
Beware, if you begin the rollover process but don’t complete the deposit into your new account within 60 days, it’s considered a distribution and could be subject to early withdrawal penalties. To avoid this, you can opt for a direct rollover between plans instead.
Now Down to Specifics: What Does Your Plan Offer?
Not all retirement plans are created equal. If you’re determining the quality of an employer’s retirement plan, there are a few key areas to look at and consider.
Some employers require you work for a certain amount of time before you are allowed to start contributing to the plan. There are different eligibility guidelines employers must follow for each type of plan, but it’s important to know when you will be able to take advantage of this benefit.
Now to the good stuff. How much, if anything, is your employer willing to match you? Some employers will match up to a certain percentage; others might match your entire contribution. This isn’t money you see today, but it can go a long way in building your nest egg.
For example, with a $60,000 annual salary, if your employer matches 3% on monthly contributions for the five years you work there, they will contribute $150 per month, or $9,000. That doesn’t even take into account potential investment gains.
While your contributions to a plan are always 100% vested (or 100% yours, in other words), employer contributions might be on a vesting schedule. This means your percentage of ownership of those funds increases after a certain amount of time with the company. You might be 100% vested after three years, for instance, or you could be 20% vested after one year, 40% vested after two, etc. Generous plans might even say you’re vested immediately.
This is important to note if you want to take advantage of an employer match but you don’t plan on staying put for a few years.
Fees are the slow leak that can quickly drain your savings if you aren’t careful. And these can vary drastically from plan to plan and employer to employer. A plan with a smaller employer could carry larger fees, while a plan with a larger employer can spread the fees more effectively. Either way, make sure you know exactly what you’re on the hook for. Even a fee difference of 1% annually can mean thousands in lost retirement savings.
If you are uncomfortable with investing, target date retirement funds can be a great option. Based on your age and target retirement date, your portfolio will be readjusted, so you aren’t overly risky when you don’t have the time to make up potential losses. But not all plans offer target date funds or other investment options you may be interested in.
Take the time to see what is available to you and if it will help reach your savings goals.
Don’t Hesitate to Ask Questions
Retirement can seem like an overly complicated subject and, quite honestly, it is. But don’t let intimidation be the reason you don’t ask a new or existing employer specifics about the plan they offer. If they don’t know how to answer the questions, chances are they can point you in the direction of a resource that can.
Whatever you do, don’t leave this extra benefit on the table.