An Employer-Sponsored Retirement Plan is an investment plan that employers offer to their employees as an added benefit. These plans include 401(k)s, 403(b)s, 457(b)s, SARSEPs, and SIMPLE plans. Each plan has different rules and features. But all Employer Sponsored Retirement Plans contain many of the same rules and fundamental characteristics. In this article, we will go over the basic characteristics of these plans, as well as tips for getting the most out of yours.
Retirement Plan Fundamentals
To be able to use an Employer-Sponsored Retirement Plan, it is important that you understand the fundamentals of how they work. Here are a few basic facts:
- All contributions are automatically deducted from your paycheck.
- 401(k)s, 403(b)s, 457(b)s, SARSEPs, and SIMPLE plans are all funded with pretax dollars. This means that your money is put into your retirement account before your employer takes taxes out.
- Some 401(k)s, 403(b)s, and 457(b)s may allow you to make after-tax contributions. Funding your account this way will make your distributions tax-free.
- Most plans offer employer matching for all, or a percentage, of your contributions.
- Your funds grow tax-deferred. This means that you do not pay taxes on contributions or investment earnings until the money is withdrawn.
- If you take money out early you will be subject to an early withdrawal penalty, on top of the income taxes you will owe.
- Funds held in an employer-sponsored retirement plan are safe from creditor claims.
You can also talk to your employer benefits officer or a financial advisor to get a thorough explanation of your plan’s benefits.
Contribute, Contribute, Contribute
The best thing you can do to take advantage of an Employer-Sponsored Retirement Plan is to contribute. The more you save, the better chance you will have to retire comfortably. So, make it a goal to max out your contributions to the legal limit.
Not only will contributions help you save for retirement, but you will also save on taxes. Your pretax contributions lower your taxable income for the year. Which means you have less income subject to taxes. For example, if you earn $50,000 and contribute $7,500, you will only be responsible for taxes on $42,500.
Your contributions also benefit from tax-deferred growth. This will allow your earnings to compound each year, tax-free. You can make a substantially greater amount this way than someone who invests taxable assets at the same rate of return.
Tax Advantage of Employer Matching
If you are not able to contribute the legal maximum amount, try and contribute to the limit that your employer will match. Employer matching is basically free money. If you are not utilizing it you would be passing on a significant amount of future monies. For example, let’s say you earn $30,000 a year and your employer will contribute $0.50 for every $1 that you contribute, up to 6% of your income. This means that you could contribute $1,800 a year and your employer would contribute $900, giving you a total of $2,700 in contributions to your retirement plan.
Carefully Weight Investment Choices
Typically, your Employer-Sponsored Retirement Plan will give you a selection of mutual funds or other investments that you can choose from. Which investments you select are very important since varying rates of return can make a big difference in your final balance. It is a best practice to get advice from a financial professional. They can help you make a decision based on your goals, risk tolerance, and the amount of time until you retire. They can also coordinate your plan with any other investments you may have.
When You Leave Your Employer
When you leave your employer, you will have several different options regarding what you want to do with your plan. These options include:
- Lump Sum Distribution: If you choose to take a lump-sum distribution you will have to pay income tax on the full amount and pay an early withdrawal penalty if you are under 59 .
- Leave Funds with Employer: If you balance is too small, or you are under 59 , this might be your only option.
- Rollover: You may want to roll your fund over into your new employer’s plan or an IRA. If done correctly, rolling your account over will help you avoid income tax and penalties. Your funds will also continue to grow tax-deferred.
Employer-Sponsored Retirement Plans are powerful investment tools. Do not let yours go to waste. Enroll if you have not already. If you are already enrolled, make sure that you are utilizing it to the fullest.
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