When it comes to retirement planning, the options can sometimes seem overwhelming. Individuals may be able to participate in employer-sponsored plans, and they may also have their own separate retirement savings. Today and tomorrow, business consultant and HR Daily Advisor contributor Bridget Miller provides the basics on the various retirement benefit plans that employers may offer to employees.
From an employer standpoint, retirement planning is not just a benefit, it’s also a matter of legal compliance. While no regulations require employers to provide a retirement plan, those employers who opt to do so are subject to specific Employee Retirement Income Security Act (ERISA) guidelines for the administration of such a plan. ERISA outlines standards in order to protect employees who participate in retirement plans offered by employers or others in the private sector.
Typically, employer-provided retirement plans fall into one of two categories: defined benefit plans or defined contribution plans. We will take a look at the most common examples of each.
Defined Benefit Plans
A defined benefit plan pays a set amount upon retirement. Typically, this amount is based on a formula that includes variables such as length of employment and final, average, or highest salary level.
In these types of plans, the employer is responsible for the payout regardless of where the funds come from. The employee typically does not make contributions but is not legally precluded from doing so; there are limits on the amount a participant can contribute in plans that operate in this way.
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Examples of defined benefit plans include:
- Pensions. Pensions typically pay out at retirement based on a formula as we noted above. The federal agency that guarantees pensions is the Pension Benefit Guarantee Corporation (PBGC).
- Annuities. Annuities typically provide a fixed payment amount in retirement. There are many options for annuities—they differ based on whether or not the benefit continues (and at what percentage) for the employee’s spouse after the individual dies. Some annuities also can be offered as a lump sum option at retirement.
Defined Contribution Plans
A defined contribution plan pays an amount that is based on contributions during employment and how much the invested money grows before it is distributed. In this type of plan, the employee and the employer can both contribute, and the amounts each contribute can vary. Some employers offer generous contributions; others simply offer the plan for the employee and opt not to contribute to it. In defined contribution plans, often the employee can choose how the money is invested by choosing from various plan options, which are predefined.
Here are some examples of defined contribution plans:
- 401(k). This is the most common plan that comes to mind when thinking of employer-provided retirement plans. Usually, employees and employers both make contributions to the plan. With a traditional 401(k), the employee’s contributions are made pretax, and they are taxed later when they are distributed. There are regulations that limit how much the employee and employer can contribute in a given benefit year. Besides the traditional 401(k), there are multiple subtypes of 401(k)s as well:
- Automatic enrollment 401(k). In this type, the employee enrollment is set up as “opt-out” rather than “opt-in,” which means employees will be enrolled (and are advised as such) unless they manually exclude themselves.
- Roth 401(k). In a Roth 401(k), the employee contributions are made after taxes rather than pretax. This allows the employee to take the distributions tax-free later.
- Safe harbor 401(k). This type of 401(k) was designed to help ensure that employers (especially small employers) meet nondiscriminatory rules surrounding 401(k) administration. It sets up specific contribution amounts for the employer to minimize the potential for inadvertent discrimination.
- SIMPLE 401(k). SIMPLE stands for Savings Incentive Match Plans for Employees of Small Employers.
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- 403(b). A 403(b) plan is a plan that acts nearly the same as a 401(k), but it is specifically for tax-exempt employers, such as schools, some hospitals, and state governments. Unlike 401(k) plans, these plans can be administered by third parties. Like 401(k) plans, these can be administered as a Roth 403(b).
- 457 Plan. A 457 plan is yet another similar plan to a 401(k). Like a 403(b), the 457 is available for tax-exempt employers. They can opt to offer 403(b) plans, 457 plans, or both. Like 403(b) plans, these plans can be administered by third parties. The biggest difference between a 457 plan and a 403(b) plan is the 457 plan does not have penalties for withdrawals before age 59½ (as long as the employee no longer works for the employer). However, it cannot be rolled into an IRA, unlike the previous two options.
- Thrift Savings Plan. This is a plan for government employees. It operates similarly to a 401(k).
In tomorrow’s Advisor, Miller shares more on retirement plan options (including IRAs and profit-sharing), plus an introduction to the all-things-HR-in-one-place website, HR.BLR.com.