Your Financial Future:
Employer Retirement Savings Accounts: Two Basic Types
There are two basic types of retirement savings plans offered by employers - defined benefit plans and defined contribution plans.
1. Defined Benefit Plans
- The employer often provides all of the money and selects a plan administrator to make the investment decisions.
- At retirement, the employee gets a specific monthly benefit, usually based on your age at retirement, rate of pay and the number of years you worked.
- Defined benefit plans are insured by the federal government.
How do I become a member of the pension plan at my job?
- Ask your employer or the human resource manager if there is a pension plan. If there is a plan, ask how you would become a member.
- Under the law, your employer can decide which employees are covered by the pension. Women working part-time or as independent contractors are not likely to be covered.
How many years do I need to work to be eligible for a pension?
- Under many defined benefit pension plans, you will be eligible to receive benefits at retirement after you are on the job 5 years. It can vary between 3 and 7 years, so check with your plan. This is called vesting. If you leave before you are vested, you will forfeit the benefit.
What is Social Security integration?
- Some defined benefit pension plans reduce employee pensions by subtracting part of the employee’s Social Security benefit from the pension benefit.
2. Defined Contribution Plans
- The employee may provide all or a portion of the funds and decide how to invest the money.
- Sometimes the employer matches part or all of the employee contribution.
- The most common is a 401(k) plan.
What is a 401(k) or 403(b)?
A 401(k), a type of defined contribution plan, is a savings arrangement through which you can set aside money for retirement.
- The money you contribute is taken from your paycheck before taxes.
- You decide how to invest it.
- You pay taxes only when you withdraw the money.
- You can withdraw the money without penalty after age 59½.
A 403(b) plan operates very much like a 401(k) and is used by tax-exempt organizations.Advantages of 401(k)s:
- It lowers your taxable income.
- A 401(k) plan is “portable,” meaning that you can take the amount you contributed, plus earnings, with you when you change jobs. The money can be rolled over into an individual retirement account (IRA) or another qualified 401(k) plan.
- Some employers even contribute to or match your contribution. If you stayed long enough at the job, you can take your employer’s contribution with you as well.
Disadvantages of 401(k)s:
- The employee has to decide how much to contribute to the plan and where to invest it.
- The amount that you have in your 401(k) at retirement depends on your personal investing skills and on the amount you have been able to contribute.
- Some people cannot afford to participate.
How do I become a member of the retirement plan at my job?
- Ask your employer or the human resource manager if there is a retirement plan. If there is a plan, ask how you would become a member.
- Under the law, your employer can decide which employees are covered by the plan.
- Women working part-time or as independent contractors are not likely to be covered.
How many years do I need to work to be eligible for retirement?
- If you are in a 401(k) plan, you can always take the money you contributed with you.
- However, if your employer contributed any money, you will have to be vested before you can take those contributions with you when you leave. Usually you will be eligible for your employer’s contributions after 3 years, but you should always check to make sure that you know the specific rules of your plan.