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Employer-Sponsored Retirement Plans: One Size Doesn’t Fit All

Employer-Sponsored Retirement Plans: One Size Doesn’t Fit All

| June 21, 2022
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There is no one size fits all employer-sponsored retirement plan. In fact, there are a variety of plan options available, many of which are low-cost and can help you save for retirement much faster.

 

For starters, let’s talk about what an employer-sponsored retirement plan is.

Not only do employer-sponsored retirement savings plans provide benefits for employers, but they are also a great resource for employees. Some benefits include contributions deducted from your paycheck directly, tax advantages, and, in some cases, employer matching contributions – which is basically free money.

 

Now, because every business and every employee have different needs, there are different types of plans.

There are many types of retirement plans including 401(k) plans, 457 plans, Roth 401(k) plans, SIMPLE plans, 403(b) plans, and many more. Looking at the features of each plan and talking the options over with your financial professional will help you to determine the best plan for you.

 

Two main categories define retirement plans: a defined benefit plan and a defined contribution plan.

  • Defined Benefit Plans (A.K.A. Pension Plans) are retirement plans funded completely by employers. At retirement, the employee receives a predefined benefit amount.
  • Defined Contribution Plans(DC Plans) are funded by contributions from both employer and employee. Participants receive a benefit amount based on contributions, plus any gains or less any losses from investments

 

Defined contribution plans are the most common employer-sponsored plans today. There are seven different plans available that your employer may offer…

 

1. Defined Benefit Pension Plans

Defined benefit pension plans are defined contribution plans.

  • Contributions are made by the employer; the employee is not responsible for making any contributions
  • All investment decisions are made by the employer
  • The employee receives a fixed monthly benefit during retirement
  • Monthly benefit amounts are based on the employee income and years of service

Despite being also known as traditional retirement plans, they are rare because they have been replaced by defined contribution plans.

 

2. 401(k) Plan

401(k) plans are the most common employer-sponsored retirement plans, primarily offered by large, for-profit businesses, and are defined contribution plans.

  • Contributions made by the participating employee
  • Often comes with some level of employer-matching contributions
  • The employee chooses which investments to put their funds into and will have complete control over the money upon reaching retirement
  • Contributions are tax-deductible in the year they are made
  • Investment earnings accumulate on a tax-deferred basis
  • Distributions will be taxable as ordinary income

  

3. Roth 401(k) Plan

  • Roth 401(k) plans provide the benefits of a regular Roth IRA
  • Employee contributions are the same as those for a regular 401(k) plan
  • An employer can offer a partial match on a Roth 401(k); however, the employer contribution must be placed into a regular 401(k)
  • Contributions are not tax-deductible
  • Investment earnings accumulate on a tax-deferred basis
  • Roth 401(k) plans are subject to the IRS-required minimum distribution (RMD) rule that requires distributions to be taken once the employee retires
  • Distributions from the plan are tax-free

 

4. 403(b) Plan

403(b) plans are virtually identical to 401(k) plans, except they are only offered in nonprofit organizations. This includes public school systems, hospitals, home health service agencies, welfare service agencies, churches, and conventions and associations of churches.

  • Contributions made by employees
  • Employers can match contributions up to a certain percentage
  • The employee chooses which investments to put their funds into and will have complete control over the money upon reaching retirement
  • Contributions are tax-deductible when made
  • Investment earnings accumulate on a tax-deferred basis
  • Distributions will be taxable as ordinary income

 

5. 457 Plan

457 plans are essentially 401(k) plans for state and local government employees. They work the same way as 401(k) plans and have identical contribution limits.

  • Contributions made by the participating employee
  • Often comes with some level of employer-matching contributions
  • The employee chooses which investments to put their funds into and will have complete control over the money upon reaching retirement
  • Contributions are tax-deductible in the year they are made
  • Investment earnings accumulate on a tax-deferred basis
  • Distributions will be taxable as ordinary income

There's one significant difference, between a 457 plan and a 401(k) plan. Should an employer offer both a 457 plan and a 401(k) plan, the employee can fully contribute to both plans, allowing for contributions that double the limit for a 401(k) plan.

A 457(b) plan is not subject to the age 59 1/2 withdrawal rule. This means there is no 10% penalty for early withdrawal at retirement or upon termination of employment. Note: This benefit applies only to public (governmental) plans. Private plan participants generally will pay federal income taxes when funds are made available to them. They may, however, defer receiving funds and instead be taxed when they actually take a distribution.

 

6. SIMPLE Plan

SIMPLE stands for Savings Incentive Match Plan for Employees and are IRA plans typically offered by small businesses.

  • The employee makes contributions to the plan
  • The employer must make either matching contributions (up to 3% of the employee’s salary) or nonelective contributions
  • The employee chooses which investments to put their funds into and will have complete control over the money upon reaching retirement
  • Contributions are tax-deductible in the year they are made
  • Investment earnings accumulate on a tax-deferred basis
  • Distributions will be taxable as ordinary income

  

7. SEP Plan

A SEP is a Simplified Employee Pension plan typically offered by small businesses. Like a SIMPLE plan, SEP plans are based on IRAs and are also known as SEP-IRA plans.

  • Employers make contributions to the plan on behalf of the employee; the employee cannot contribute to their account
  • The employee chooses which investments to put their funds into and will have complete control over the money upon reaching retirement
  • Contributions are tax-deductible in the year they are made
  • Investment earnings accumulate on a tax-deferred basis
  • Distributions will be taxable as ordinary income

 

 

It’s important to research your employer to find out what retirement plans and investment options they offer and which plan is the best for your situation.

Still not sure which option is right for you? CONTACT US today! We’d be happy to answer your questions and help get you on the right path.

 

 

SOURCES:
https://dgkgrouppc.com/common-types-of-employer-sponsored-retirement-plans/
https://investorjunkie.com/retirement/employer-sponsored-retirement-plans/
https://www.investopedia.com/terms/i/ira.asp
https://www.investopedia.com/terms/d/definedbenefitpensionplan.asp

 

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