Personal Finance 101: Employer Retirement Plans

What Are Workplace Retirement Plans?
•    Workplace plans offer an easy and convenient way to save for retirement through payroll deductions.
•    Retirement savings plans offered by employers fall into two categories: defined benefit plans and defined contribution plans.
•    Many employers offer a company match when you contribute a percentage of your paycheck to the plan. 

Achieving financial security in retirement is an important goal for everyone, and it’s why prioritizing retirement savings during your working years is a key strategy. Fortunately, employer-sponsored retirement plans are some of the most convenient and easiest ways to save for your future. 

Types of Employer Retirement Plans
Workplace plans generally fall into two categories: defined benefit and defined contribution plans. Some employers may offer one of them, or both.

A defined benefit plan is a retirement account that your employer sponsors and manages. As an employee you don’t have to contribute, and you are promised a set payout when you retire. 

A defined contribution plan, on the other hand, requires you to put in your own money; your employer may offer matching funds, though it’s not required to do so. The amount available to you at retirement depends on how much you, and potentially your employer, have invested and what return those investments have earned.

What Are Defined Benefit Plans?
Defined benefit plans are also known as pensions. With a pension, your employer sets aside money for your retirement while you are working, and you’ll receive the funds, typically in the form of a monthly check, once you retire. 

The amount of money your employer invests and how much you receive in retirement depends on several factors, including your age, your years of service with the company and often your average salary during the last few years before you retire. Today, few employers offer pension plans, since many have transitioned over to defined contribution plan options like 401(k) accounts.

A cash-balance plan is another type of defined benefit plan. These plans are similar to pensions, but the employer contributes a set percentage of your salary each year. 

Employers that offer pension or cash-balance plans often require an employee to become “vested” in the plan by staying on the job for a certain number of years before they’re eligible to receive benefits.

What Are Defined Contribution Plans?
Many employers today offer defined contribution plans, in which employees contribute their own money and manage their own investments.

Defined contribution plans include:
 401(k) accounts. These plans are primarily offered by for-profit companies and are funded via pre-tax payroll deductions. Money grows tax-free a 401(k), but all withdrawals in retirement will be taxed. You generally must be at least 59½ to withdraw funds from a 401(k) without incurring a 10% early-withdrawal penalty, in addition to taxes. This early-withdrawal penalty doesn’t apply, however, if you leave a job (whether by choice or not) during the year you turn age 55 or after. In that case, you may take penalty-free withdrawals from that employer’s retirement plan (taxes will still apply). 

Roth 401(k) accounts. With a Roth 401(k), you don’t get a tax break on the money you contribute now. Instead, your withdrawals in retirement will be tax-free. But you can make withdrawals of your contributions at any time without penalty. And you can make withdrawal of your earnings without penalty once you’ve reached age 59½ and have held the account for at least five years. 

403(b) accounts. A 403(b) plan is similar to a 401(k), though it’s typically offered to employees of nonprofit organizations. Like a 401(k), a 403(b) allows plan participants to contribute pre-tax money, enjoy tax-free investment growth potential, and then pay income tax on withdrawals in retirement. The same early-withdrawal rules that apply to 401(k)s also apply to 403(b) plans. 

457 accounts. These plans are similar to 401(k) and 403(b) plans but are typically established by state or local governments for their public-sector workforce. Employees make pre-tax contributions, which grow tax-free until funds are withdrawn. Unlike 401(k) and 403(b) plans, however, you may withdraw money from a 457 plan penalty-free at any age—provided you are separated from employment.

There are limits to how much employers and employees can contribute to a plan each year. For all the accounts listed above, you can contribute up to $19,000 in 2019, plus an additional $6,000 “catch-up” contribution if you are 50 or older. In addition, 403(b) plans allow some employees to make extra contributions after 15 years of service with the same employer. You can find the current year’s limits at IRS.gov.

How Employer Retirement Plans Work
If you’re lucky enough to have a defined benefit plan, you may not have to do much, if anything, to manage your plan. Defined contribution plans, by contrast, require employees’ involvement at a number of points. For instance, some plans require you to enroll yourself, while others enroll you automatically. Once enrolled, you can set your contribution rate, which is typically expressed as a percentage of your annual salary. Some plans enroll employees at a default contribution rate, though you can raise or lower that rate at any point.

Once you’re enrolled, you can decide how to invest your contributions. Your employer may offer a default choice—usually a target-date fund, which holds a mix of stocks and bonds selected to align with your age and the length of time you have until retirement. Over time, the professional money managers who oversee the fund will adjust the mix of investments, gradually becoming more conservative as you get closer to retirement.

If you pick your own investments, aim to choose a mix of stock and bond mutual funds. The longer you have until retirement, the more of your assets you'll typically want to invest in stocks, which have historically offered higher long-term returns than bonds, but may be riskier.

Once your investments and contribution rates are set, your contributions, along with any employer matching funds, are made automatically every pay period. 

How to Get the Most Out of Your Plan
To get the most out of your retirement savings, try to contribute as much as you can as early in your career as possible. You might start by contributing enough to get the full company match if offered. Then, you can increase your contribution over the years as your salary increases. (Some employers offer automatic escalation features, which increase your contribution amount by one or two percentage points annually).

Putting away as much as you can early on also exposes your investments to compound interest growth, meaning any earnings on your investments then produce earnings of their own. The earlier you start saving for retirement, the longer your savings have to benefit from compound growth. 

Avoid taking early withdrawals from your 401(k) before the age of 59½. If you do, you will have to pay a 10% penalty on top of income tax on the distribution—and you’ll miss out on the chance for potential growth on those assets.  Finally, pay attention to the expense ratios of investments and administration fees, which can take a bite out of your savings. Consider selecting low-fee investments to help position you well for a comfortable retirement.