Employers usually offer retirement plans to their employees because the promise of a secure retirement represents an effective way to recruit and retain valuable workers. An employer-sponsored retirement plan is an IRS-approved plan offered by an employer. These are called qualified plans. Approximately one-third of all workers at small firms voluntarily participate in an employer-sponsored retirement plan, compared with four-fifths of workers in medium-size to large firms. Participating in such a plan can serve as the cornerstone of your retirement planning. If you do not have access to an employer plan, you should make alternative preparations for retirement
The Employee Retirement Income Security Act (ERISA) does not require companies to offer retirement plans, but it does regulate those plans that are provided. ERISA calls for proper plan reporting and disclosure to participants. Three types of employer-sponsored retirement plans are available: defined-contribution, definedbenefit, and cash-balance.
Defined-Contribution Retirement Plan Today’s Standard
A defined-contribution retirement plan is designed to provide a lump sum at retirement. It is distinguished by its “contributions” that is, the total amount of money put into each participating employee’s individual account. The eventual retirement benefit in such an employer-sponsored plan consists solely of assets (including investment earnings) that have accumulated in the various individual accounts. In a noncontributory plan, money to fund the retirement plan is contributed only by the employer. In a contributory plan, money to fund the plan is provided by both the employer and the participant or solely by the employee. Most plans are contributory.
When you elect to participate and contribute to such a retirement plan, you take a portion of your salary and postpone receiving it. That money goes into your account. Because it goes there before you receive it, those funds are not subject to income taxes. Defined-contribution retirement plans are also known as salary-reduction plans because the contributed income is not included in an employee’s salary. The tax-free contributions are designated as such on the employee’s W-2 form. Financial expert Steve Lansing says a defined-contribution plan can be viewed as an interest-free loan from the government, via the income taxes saved, to help finance one’s retirement.
Each employee’s contributions are deposited with a trustee (usually a financial institution, bank, or trust company that has fiduciary responsibility for holding certain assets), which invests the money in various securities, including mutual funds, and sometimes the stock of the employer. Each employee’s funds are managed in a separate account. Employers who offer a defined-contribution account may choose to establish an automatic enrollment plan for employees. Employees are registered and the employer withholds up to 3 percent of the employee’s salary and puts that amount into each worker’s account in an automatically diversified portfolio. Over time, the employer may choose to automatically increase the withholding to 6 percent, or the company maximum. Employees have the right to opt out of this kind of “automatic” plan, although taking such action defeats a valuable way to save for retirement. Defined-contribution retirement plans are also called selfdirected because the employee controls the assets in his or her account. The individual selects how to invest, how much risk to take, how much to invest, and how often contributions are made to the account.
Over time, the balance amassed in such an account consists of the contributions plus any investment income and gains, minus expenses and losses. The contributions devoted to the account are specified (defined). The future amount in the account at retirement will not be known until the individual decides to begin making withdrawals. This uncertainty occurs because the sum available to the retiree depends on the success of the investments made.
Names of Defined-Contribution Plans Several types of employer-sponsored defined-contribution plans exist. The most common are the 401(k), 403(b), and 457 plans (named after sections of the IRS tax code) and the SIMPLE IRA. Each plan is restricted to a specific group of workers. You may contribute to these plans only if your employer offers them. The 401(k) plan is the best-known defined-contribution plan. It is designed for employees of private corporations. Eligible employees of nonprofit organizations (colleges, hospitals, religious organizations, and some other not-for-profit institutions) may contribute to a 403(b) plan that has the same contribution limits. Employees of state and local governments and non-church controlled tax-exempt organizations may contribute to 457 plans. Only employees (not employers) make contributions into the plan. When the employing organization has 100 or fewer employees, it may set up a Savings Incentive Match Plan for Employees IRA (SIMPLE IRA). Regulations vary somewhat for each type of plan.
Matching Contributions Many employers offer a full or partial matching contribution (up to a certain limit) to the employee’s account in proportion to each dollar of contributions made by the participant. The match might be $1.00 per $1.00 up to the first 3 percent of pay. More common is $0.50 per $1.00 up to the first 6 percent of pay. Because your employer makes a contribution to your account every time you do, in effect you obtain an “instant return” on your retirement savings. Saving $4000 a year with a $0.50 employer match immediately puts $2000 more into your retirement account. This concept is illustrated in Table 17.3.
Limits on Contributions There are limits on the maximum amount of income that an employee may contribute to an employer-sponsored plan. The maximum contribution limit to 401(k), 403(b), and 457 plans is $15,500; the maximum is $10,500 for SIMPLE IRA plans. These figures rise yearly with inflation.
Catch-up Provision A catch-up provision permits workers age 50 or older to contribute an additional $5000 to most employer-sponsored plans. Millions of people who are getting a late start on saving including women who have gone back to work after raising children can put more money away for retirement.
Vesting Gives You Rights to Your Benefits Employers may require a waiting period of one year before allowing new employees to participate in the comselfpany’s retirement plan. To be eligible for any retirement benefits, an employee must first participate in the employer-sponsored retirement plan. Vesting ensures that a retirement plan participant has the right to take full possession of all employer contributions and earnings if the employee is dismissed, resigns, or retires. If an employee has not worked long enough for the employer to be vested before leaving his or her job, the employer’s contributions are forfeited back to the employer’s plan. The employee has no rights to any of those funds. Once vested, the worker has a legal right to the entire amount of money in his or her account in a defined-contribution plan. No matter when you leave an employer, you always have a vested right to the money that you personally contributed to that retirement account. Some employers permit immediate vesting, whereby the employees owns the money just as soon as the employer deposits funds into their retirement accounts. Employees, by law, must be vested no later than specified by one of the following options:
The Employee Retirement Income Security Act (ERISA) does not require companies to offer retirement plans, but it does regulate those plans that are provided. ERISA calls for proper plan reporting and disclosure to participants. Three types of employer-sponsored retirement plans are available: defined-contribution, definedbenefit, and cash-balance.
Defined-Contribution Retirement Plan Today’s Standard
A defined-contribution retirement plan is designed to provide a lump sum at retirement. It is distinguished by its “contributions” that is, the total amount of money put into each participating employee’s individual account. The eventual retirement benefit in such an employer-sponsored plan consists solely of assets (including investment earnings) that have accumulated in the various individual accounts. In a noncontributory plan, money to fund the retirement plan is contributed only by the employer. In a contributory plan, money to fund the plan is provided by both the employer and the participant or solely by the employee. Most plans are contributory.
When you elect to participate and contribute to such a retirement plan, you take a portion of your salary and postpone receiving it. That money goes into your account. Because it goes there before you receive it, those funds are not subject to income taxes. Defined-contribution retirement plans are also known as salary-reduction plans because the contributed income is not included in an employee’s salary. The tax-free contributions are designated as such on the employee’s W-2 form. Financial expert Steve Lansing says a defined-contribution plan can be viewed as an interest-free loan from the government, via the income taxes saved, to help finance one’s retirement.
Each employee’s contributions are deposited with a trustee (usually a financial institution, bank, or trust company that has fiduciary responsibility for holding certain assets), which invests the money in various securities, including mutual funds, and sometimes the stock of the employer. Each employee’s funds are managed in a separate account. Employers who offer a defined-contribution account may choose to establish an automatic enrollment plan for employees. Employees are registered and the employer withholds up to 3 percent of the employee’s salary and puts that amount into each worker’s account in an automatically diversified portfolio. Over time, the employer may choose to automatically increase the withholding to 6 percent, or the company maximum. Employees have the right to opt out of this kind of “automatic” plan, although taking such action defeats a valuable way to save for retirement. Defined-contribution retirement plans are also called selfdirected because the employee controls the assets in his or her account. The individual selects how to invest, how much risk to take, how much to invest, and how often contributions are made to the account.
Over time, the balance amassed in such an account consists of the contributions plus any investment income and gains, minus expenses and losses. The contributions devoted to the account are specified (defined). The future amount in the account at retirement will not be known until the individual decides to begin making withdrawals. This uncertainty occurs because the sum available to the retiree depends on the success of the investments made.
Names of Defined-Contribution Plans Several types of employer-sponsored defined-contribution plans exist. The most common are the 401(k), 403(b), and 457 plans (named after sections of the IRS tax code) and the SIMPLE IRA. Each plan is restricted to a specific group of workers. You may contribute to these plans only if your employer offers them. The 401(k) plan is the best-known defined-contribution plan. It is designed for employees of private corporations. Eligible employees of nonprofit organizations (colleges, hospitals, religious organizations, and some other not-for-profit institutions) may contribute to a 403(b) plan that has the same contribution limits. Employees of state and local governments and non-church controlled tax-exempt organizations may contribute to 457 plans. Only employees (not employers) make contributions into the plan. When the employing organization has 100 or fewer employees, it may set up a Savings Incentive Match Plan for Employees IRA (SIMPLE IRA). Regulations vary somewhat for each type of plan.
Matching Contributions Many employers offer a full or partial matching contribution (up to a certain limit) to the employee’s account in proportion to each dollar of contributions made by the participant. The match might be $1.00 per $1.00 up to the first 3 percent of pay. More common is $0.50 per $1.00 up to the first 6 percent of pay. Because your employer makes a contribution to your account every time you do, in effect you obtain an “instant return” on your retirement savings. Saving $4000 a year with a $0.50 employer match immediately puts $2000 more into your retirement account. This concept is illustrated in Table 17.3.
Limits on Contributions There are limits on the maximum amount of income that an employee may contribute to an employer-sponsored plan. The maximum contribution limit to 401(k), 403(b), and 457 plans is $15,500; the maximum is $10,500 for SIMPLE IRA plans. These figures rise yearly with inflation.
Catch-up Provision A catch-up provision permits workers age 50 or older to contribute an additional $5000 to most employer-sponsored plans. Millions of people who are getting a late start on saving including women who have gone back to work after raising children can put more money away for retirement.
Vesting Gives You Rights to Your Benefits Employers may require a waiting period of one year before allowing new employees to participate in the comselfpany’s retirement plan. To be eligible for any retirement benefits, an employee must first participate in the employer-sponsored retirement plan. Vesting ensures that a retirement plan participant has the right to take full possession of all employer contributions and earnings if the employee is dismissed, resigns, or retires. If an employee has not worked long enough for the employer to be vested before leaving his or her job, the employer’s contributions are forfeited back to the employer’s plan. The employee has no rights to any of those funds. Once vested, the worker has a legal right to the entire amount of money in his or her account in a defined-contribution plan. No matter when you leave an employer, you always have a vested right to the money that you personally contributed to that retirement account. Some employers permit immediate vesting, whereby the employees owns the money just as soon as the employer deposits funds into their retirement accounts. Employees, by law, must be vested no later than specified by one of the following options:
- Cliff vesting. The employee is fully vested within three years of employment.
- Graduated vesting. Employees must be at least 20 percent vested after two years of service and gain an additional 20 percent of vesting for each subsequent year until, at the end of year six, the account is fully vested.
Retirement Plan Contribution Tax Credit for Low-Income and Moderate-Income Savers Singles with adjusted gross incomes of less than $25,000 and joint filers earning less than $50,000 can claim a nonrefundable retirement plan contribution credit (also known as a saver’s tax credit). This credit ranges from 10 to 50 percent of every dollar they contribute to an IRA or employersponsored retirement plan up to $2000.
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