A Guide to Workplace Retirement Plans

By Hightower Westchester on November 1, 2021

As we approach the end of the year and the beginning of open enrollment, we wanted to provide you with a guide to workplace retirement plans. These plans are the backbone of retirement savings for most Americans and should be taken advantage of whenever possible. For many years, it was commonplace to participate in a defined benefit plan, or as many of you know it, a pension plan, but today many of those plans are not available and most employers offer defined contribution plans such as 401(k)s and 403(b)s instead.

Much of the workforce here in the U.S. will derive their retirement income from these plans. Planning for retirement is truly a lifelong process that often begins when you start working. It is important to know what you are getting into and we hope this blog can help.

First, let’s start with what a qualified retirement plan is. Qualified retirement plans are tax-advantaged retirement plans that are subject to Employee Retirement Income Security Act (“ERISA”) rules, as well as other IRS guidelines. These guidelines spell out several different requirements such as minimum participation, annual contribution limits, and vesting schedules. Examples include 401(k)s and 403(b)s.

On the other side are non-qualified retirement plans. Simply put, these are employer-sponsored retirement plans that do not have to meet ERISA guidelines. Non-qualified retirement plans are frequently designed to meet specialized retirement needs for key executives and other select employees and can act as recruitment or employee retention tools. Examples include executive bonus plans and deferred compensation.

In this piece we will focus on qualified retirement plans as they make up the majority of what will be offered to you, while non-qualified retirement plans tend to be more customized to each specific situation.

Starting off with a defined benefit plan or the promise of a specified benefit at retirement. The plan may state this promised benefit as an exact dollar amount, such as $100 per month at retirement, or it may calculate a benefit through a formula that considers factors such as years of service and/or compensation. The common example of a defined benefit plan is a pension plan where it is required that one sets aside money, along with the employer, into a fund for growth and withdrawal at a certain future date. The benefits in most traditional defined benefit plans are protected, within certain limitations, by federal insurance. That said, these plans are few and far between in today’s day and age.

Defined contribution plans, on the other hand, are more common workplace retirement plans.  They are funded by the employee and oftentimes, a combination of both the employee and the employer, in the form of an employer-match. The most well-known contribution plans are the 401(k) offered by private-sector employers, 403(b) plans which are offered by charitable or educational organizations such as schools and hospitals, and the 457 plans for employees of state and municipal governments.

To fund a defined contribution plan, the contribution amount you select comes out of your paycheck without any taxes assessed. In some companies, employers will match a portion of your contributions. By making this pre-tax contribution, your taxable income is reduced, up to a certain amount, by the sum of your contributions. Any gains that should take place within the account then grow tax deferred. We always advise clients that even if you cannot afford to contribute the maximum amount each year, make sure you at least contribute enough to get the full amount of your employer’s match.

Many employers will offer a Roth 401(k) or after-tax option as well. This offering often depends on various factors such as age, tax bracket, etc. so we recommend consulting your advisor or accountant before making any decisions.

Defined contribution plans offer a variety of investment options, although not a significant amount. It is up to the employee to select among these options and/or make any changes they see fit.

These plans can also be moved if you change jobs or retire. You can roll them into your next employer’s plan, or you can roll them into another type of retirement savings tool, such as an IRA. Due to the limited investment options within these plans, and at times, heavy fees, we often recommend that clients roll them into an IRA with more flexibility.

One caveat around these plans is you often need to be employed for a certain amount of time before you can access them, say six months or so. In addition, a vesting schedule is usually in place for company matching contributions (you are 100% vested in your contributions). For example, the vesting schedule could be 25% of employer contributions a year for four years. Once you’re fully vested, the employer’s contributions are fully yours.

Now that you know what these plans are and how they work, here are a few additional benefits of workplace retirement plans. Signing up is simple – your company will likely provide a guide on how to enroll and adjust your elections. Please don’t forget to add beneficiaries. Contribution limits for these types of plans are almost always higher than IRA limits. Contribution limits for 2021 are $19,500 with an additional $6,500 catch-up contribution for those age 50 or over.

Saving for retirement can seem complicated and so far out in the future that you don’t put enough emphasis on it. It is important to remember the power of compounded interest over time and that your employer might be giving away free money through their match. Please take some time and either establish a plan and/or review your current one.

If you have any further questions about these plans or something similar, please feel free to reach out.

Richard Flahive – Private Wealth Advisor and Director of Research & Planning – Hightower Westchester

914.825.8639 – rflahive@hightoweradvisors.com