Employer-Sponsored Retirement Accounts
Benefit from a company match and other incentives
An employer-sponsored retirement account is another effective way to save for retirement. A 401(k) plan is the most common employer-sponsored account. Others available include 403(b) plans for public education organizations and nonprofits, and 457 plans for government employers and workers.
Benefits of employer-sponsored plans
Employer-sponsored retirement accounts offer tax-deferred investment growth similar to an IRA with a few added benefits:
- A company match—In many plans, an employer will agree to match the funds you contribute up to a certain amount. For instance, a typical match is 50 cents on the dollar up to 6 percent of your salary. When you think about it, that match is virtually "free" money. You should always contribute enough to your 401(k) to capture the match.
- Automatic discipline—Your contributions are deducted automatically from your paycheck, making it much easier to save.
- Tax deferral on your salary—Contributions are pre-tax, so you’re deferring taxes on the income you're contributing to the plan, in addition to deferring taxes on any investment income or realized capital gains. A dollar not paid in taxes is a dollar that can generate income for you.
- Higher contribution limits—You can contribute considerably more to a 401(k) or similar plan than you can to an IRA. Limits for tax year 2016 and 2017 are $18,000 plus an additional $6,000 if you’re 50 or older.
How employer-sponsored plans work
If you work for a company that offers an employer-sponsored plan such as a 401(k), you generally need to enroll in the plan to participate (some companies provide automatic enrollment). When you enroll, you can choose the percentage of your salary you wish to contribute up to certain limits.
If your company provides automatic enrollment in a 401(k) plan, be sure that you are contributing enough to support your savings goals. If not, you can increase your contribution rate up to the legal limits.
Once enrolled in the plan:
- Your contributions are automatically taken out of your paycheck and deposited in your retirement account.
- Most plans offer you a choice of investments. Your contributions are then invested according to your choices.
- Many employer-sponsored plans offer some type of investment education to help you make your investment choices.
The Roth 401(k)—another option
The Roth 401(k) is a more recent addition to employer-sponsored plans. Similar to the Roth IRA, contributions are made with after-tax dollars, but earnings grow tax free, and you pay no income tax on withdrawals as long as you’re age 59 ½ and you’ve had the account for five years or more. Unlike the Roth IRA, there are no income limitations to participate. You may want to talk to your tax advisor before choosing a Roth 401(k) to make sure you understand what it can mean to both your current salary and your future withdrawals.
Because contributions to a traditional 401(k) are pre-tax, contributing a slightly higher percentage may not significantly reduce your paycheck. For example, if you’re in the 25 percent tax bracket and your check is $1,000, increasing your contribution from 10 to 15 percent would only lessen your take-home pay by $37.50.