I was recently watching an episode of the TV show 30 Rock where Liz Lemon, played by Tina Fey, was awarded the G.E. Followship Award (which recognizes the G.E. employee who best exemplifies a follower) along with a $10,000 prize. I chuckled along as Liz’s boss, Jack Donaghy, played by Alec Baldwin, questioned whether she was going to contribute the money to her 401k, to which Liz responded, “I should probably get one of those.”
While 30 Rock is a fictional TV show, employees not taking advantage of employer retirement plans (e.g. 401k, 403b, etc.) is not a fictional situation. And more often than not, the reason is simply because they don’t fully understand how they work or the advantages they provide – that’s where I come in! Let me break it down for you.
What is a retirement plan?
A retirement plan is an account, established through an employer, which employees can contribute a portion of their paycheck to that is earmarked specifically for retirement.
The most common retirement plans are named according to the section of the tax code that governs them:
- 401(k): offered to employees of for-profit organizations
- 403(b): offered to employees of nonprofit organizations
- 457: offered to state & local government employees
How does it work?
Each employer sponsored retirement plan has investment options that an employee can choose from, such as stocks, bonds, or mutual funds – just to name a few. Once the funds have been chosen, the employee must decide what percentage or dollar amount will be automatically deducted from each paycheck and invested into their retirement account.
What are some benefits?
Taxes: One of the main advantages to a retirement account are the tax savings. Contributions made to a traditional 401(k), 403(b), or 457 account are made with pre-tax dollars. This means that any money contributed will lower your taxable income for the year. Additionally, these types of accounts offer tax-free growth, which means the money invested will not be taxed until you withdraw the money in retirement.
Employer Matching: Another potential benefit is that a company may offer some type of employer match. This refers to a specific dollar amount an employer promises to contribute if the employee makes their own similar contribution. For example, an employer may offer to contribute a dollar-for-dollar amount up to a specific percentage (e.g. 5%) of the employee’s compensation. First, find out how much your employer is willing to match. Next, determine the minimum contribution required to get the maximum employer match. You should try to contribute at least this much, otherwise you would be missing out on what is essentially free money.
What is the maximum allowed contribution?
The IRS allows employees to contribute up to a designated amount each year ($19,000 for 2019). For those over age 50, an additional $6,000 “catch-up” contribution is permitted.
What happens to your account if you change jobs?
Employer sponsored retirement accounts are considered portable, which means you can transfer and/or consolidate your accounts if you were to find a new job. There are several options available when you leave an employer:
- Leave the money in your former employer’s plan
- Roll over the money into your new employer’s plan (if the new plan allows transfers)
- Roll over the money into a Rollover Individual Retirement Account (IRA)
The best option for you will depend on how each employer’s plan is set up. You should speak to an advisor to determine the best strategy.
When can you withdraw money without penalty?
Retirement accounts have specific conditions around withdrawing money. Any withdrawals from a retirement account prior to age 59 1/2, for any reason other than IRS approved exceptions, are subject to a 10% penalty in addition to any taxes owed.
Now that we’ve covered the basics, it’s pretty clear that contributing to an employer sponsored retirement plan is a fantastic savings strategy. Not only can you take advantage of tax savings and free money, but you can also begin to build wealth well before your retirement years.
Tune in for my next blog where we’ll explore another employee benefit: life insurance.