Guide to Employer Sponsored Plans

Feel like you're leaving money on the table when it comes to your retirement savings? Make the most of your options with our free guide to employer-sponsored plans

Making the Most of Employer Sponsored Plans Depicts Business man Holding Wood Black that Says Benefits photo of wood man walking across wood block that says benefit on it..

What You Need to Know

Today, there are two types of categories for employer-sponsored plans.  The first is a defined benefit that offers a specified payment at retirement, such as pension plans.  The other type is defined contribution, which allows employees and employers to contribute tax-deferred funds as well as invest them, such as with 401(k) or 403(b) plans, employee stock ownership plans (ESOPs), profit-sharing plans, and a simplified employee pension plans (SEP).

What’s Covered?

To help you understand the options, we’ve developed this guide to employer-sponsored plans so you can easily understand the different options, pros, and cons. Topics covered in this guide include:

      • Pension plans
      • 401(k) plans
      • Strategies
  • Separation options
  • Roth vs. IRA
  • Required minimum distributions

The Basics of Employer-Sponsored Plans

To encourage participation in company retirement plans, many employers match all or a percentage of employee contributions to their retirement plans. For instance, if your employer offers a 50-percent match on anything you contribute, up to 5 percent of your salary, you will automatically see an increase in your account. Even if your employer match is subject to a vesting schedule, you should aim to contribute enough to maximize the match. Some employers even have a required minimum you must contribute. You can learn more in our podcast on employer-sponsored plans.

Choice of Investments

Often, employer-sponsored plans offer access to investment managers not available to individual investors and without the sales charges that one might incur when investing in an individual IRA. Your employer, however, may limit your investment choices. If the available options won’t help you reach your retirement goals, you may want to supplement your portfolio with nonqualified and individual IRA savings.

 

What You Should Consider When it Comes to Pensions

Pension plans have been around for a very long time. Even during the revolutionary war, soldiers were offered a type of pension for their service. American Express was the first business in the U.S. to offer a pension plan for its employees.

In 1983 there were about 183,000 plans. In stark contrast, there were only 46,000 by 2006. Today, only 13 percent of companies still offer pension plans. Several issues plaguing these plans are behind the dramatic drop. Like Social Security, there is more money being taken out of the plan than being put in. Dropping interest rates, and the liabilities that have come with funding and payment obligations are causing many companies to retire their pensions. Currently, many companies are writing standing options into their plans to allow for the lump-sum payout.

To plot the best course of action, you’ll need to understand your plan’s health, the options available to you, or any limits based upon the time you turned on your pension. All employees should be on the lookout for their company’s Annual Fund Notice which is required to be sent to those part of the company’s pension plan. This notice states the health of the pension program, and how much funding is available. The information can help you determine if you want to leave the pension obligation with your employer or if you want to move the lump sum into a less risky alternative, like rolling it over into your IRA.

If the company managing your pension goes defunct, the Pension Benefit Guarantee Corp (PBGC) is a government-backed organization that covers the liability of any companies that declare bankruptcy. You should know, however, that they only pay up to a certain statutory limit.

401(k) Plans Help You Help Yourself

Employer sponsored plans shows linked generational hands.

When 401(k) plans came into existence in the mid-80s they started as a fluke. Benefit consultant Ted Benna, known as the father of the 401(k), was digging into the Employee Retirement Income Savings Act and the 1978 Revenue Act when he discovered the section 401(k), which allows for non-qualified deferred compensation The discovery was pivotal because it enabled employees to help themselves fund their retirements on a pre-tax basis. Equally as important is the option for matching contributions.

Where to Begin

When clients ask, we generally start the conversation by taking advantage of free money as part of your company’s matching, so you don’t leave any money on the table. Here are some considerations:

  • Does my company offer a 401(k) plan?
  • How much can I afford to withhold from my paycheck?
  • What’s my company’s matching situation?

Given the size of most companies offering them, the investment expense ratio involved with these plans is as low as any that can be found. That’s because companies have a lot of leverage with their combined total assets versus just an individual trying to save.

6 Strategies Most People Don’t Know When it Comes to Your 401(k)

Most clients don’t have any understanding of what they can do with their 401(k) plans or the options available to them like Roth and after-tax options to maximize their benefits. There are also an increasing number of Roth options inside many 401(k) plans.  Investors should consider several things to make the most of their employer-sponsored plans:

  1. Time horizon should always be considered. For example, you don’t want to get stuck in a 40 percent drawdown when you are two years from retirement
  2. Go with low-cost savings options
  3. Stay invested
  4. Manage the expenses
  5. Stay consistent with your contributions
  6. Dollar-cost averaging means ensuring there is an appropriate balance between stocks and bonds

Contribute More Than the Max

For people under age 50, the max for 2020 is $19,500, however, there is a forgotten contribution feature when it comes to after-tax accounts. The IRS states the total fund contribution maximum is $57,000 if you are under 50 or $63,500 if over the age of 50. This means that you can add additional funds after tax up to that amount using match, profit sharing, stock purchase, and contributions.

This strategy offers protection against some of the surtaxes as a result of the Affordable Care Act, namely the net investment income tax of 3.8 percent for those with adjusted gross income over $250,000. By making contributions to these you can save more for retirement, shelter it in a vehicle that is creditor protected, has all of the deferral components, and offers a lot more flexibility as to when you pull the assets out. Your financial advisor can help you work through the specifics to take advantage of the best option for you.

Tax Considerations

If you think a tax deduction will help you, or if you are under the threshold where you can contribute to an IRA, a pretax account might be worthwhile for you. For example, to keep your adjusted gross income under a certain amount, the pretax option may accomplish this.

If you have ultra-high net worth or income earnings, the appeal of Roth’s tax-free distribution may be more appealing. You’ll have to decide if it will help your tax return this year, or if tax-free assets are better off down the line.

Target Date Funds

Target date funds manage an allocation of equity and fixed income as a guide path to your targeted retirement. A Target Date Fund is designed to manage your assets more conservatively as you approach your retirement age trigger. This is desirable in managing performance that might be affected by a potential market drawdown as you near your retirement age. Investors must understand how these plans work. Speak with your financial advisor to help you select options that are suitable for your level of risk tolerance.

Separation Options: What You Should Consider

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As people transition from one employer to another, many are still uncertain about what to do with their 401(k) plan when they leave their employer. Here are 4 options you should consider when it comes to your 401(k):

Do Nothing

If you have over $5,000 invested, most plans allow you to leave it there.  In most cases, employees may be able to transfer the account to a retirement plan with their new employer.  This is especially useful if the ability to borrow against the account in the future is important, but employees should always check with their new plan for loan eligibility rules.

Net Unrealized Appreciation

Some people work for companies where they buy (or you are buying) company stock within your retirement plan. When you leave your employer, there is a crucial tax management decision on what you should do with the company stock. In essence, you have an opportunity to pay ordinary income tax on your cost basis of the company stock but pay capital gains tax on the growth if the election is done successfully. Once you roll over your 401(k) to an IRA, this election will no longer be available People who have worked for a long period for one employer where they have a sizable amount of company stock do not often realize the implication of missing out on Net Unrealized Appreciation.

Target Date

Target or Lifecycle Retirement funds that typically have a date such as Target 2035 in your 401(k) plan. The idea of these funds is that the fund company will do the work and adjust the balances until you retire in 2035. We believe one of the biggest mistakes people make with their old 401(k) plan is doing a strategy such as this, or even worse, just leaving the current mix they have in their 401(k) plan and never revisiting it on a year-to-year basis.

Cashing Out

This defeats the purpose of earmarking savings for retirement. Additionally, the consequence is that if you are under 59 ½ years of age, you will pay a 10 percent early distribution penalty. Additionally, the distribution will be treated as ordinary income in the tax year you take the distributions. This strategy could move you into a higher tax bracket. While having this flexibility in using the funds may be helpful, weigh the tax obligations carefully.

Roth IRA vs. Roth 401(k)

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If you anticipate that your marginal tax bracket will be substantially lower during your retirement, years of tax deferral through a traditional retirement account may offset your future tax bill. On the other hand, if you expect tax rates to rise in the future, you may be wise to consider putting some funds into a Roth account, giving yourself more options for tax savings.

Not everyone is eligible to contribute to a Roth retirement account. As an individual saver, you may be subject to earned income limits. But Roth retirement accounts available through your employer’s 401(k) or 403(b) plans aren’t subject to these limits, and you can generally contribute more to them than to an individual Roth IRA.

Both a Roth 401(k) and Roth IRA offer tax-free growth on your investment, but they differ in several important ways:

  • There are income limitations that may exclude you from receiving a tax deduction when contributing to a Roth IRA. In 2020, a married couple can make up to $206,000 filing jointly and $139,000 for a single filer
  • A Roth 401(k) has limitations on the types of penalty-free early withdrawals you can make
  • The Roth 401(k) has a higher contribution limit than a Roth IRA. In 2020, Roth 401(k) limits you to a $19,500 annual contribution, or a $26,000 catchup allowance if you are over age 50. The max for the Roth IRA is $6,000, or a $7,000 catchup allowance if you are over age 50
  • There are no required distributions with a Roth IRA. The distributions with a Roth 401(k) must start at age 72
  • Taxation on both the Roth 401(k) and IRA accounts happens at the time of contribution. Money put in is taxed at your ordinary-income tax rate, then the market runs its course. Upon retirement, distributions will be tax-free
  • Getting a handle on expenses for individual IRAs is easier. Between fee-based brokerage accounts, low-cost or no-load mutual funds, and other possibilities, you have a wide variety from which to choose.

Several Factors

The kind of Roth account that you choose should depend on several factors:

  • Your ContributionsThere is a combined cap on how much you can contribute to Roth 401(k) and traditional 401(k) accounts. Contributions to one will affect the other, but you are never ineligible because your salary is too high. Plus, the cap is several times higher than that on individual Roth IRAs. With an individual Roth IRA, you may not be eligible to make contributions in a year when your income is over the limit. If you are under the limit, you can contribute both to a Roth 401(k) and an individual Roth IRA.
  • Level of Expenses – Although most employer-sponsored Roth 401(k) plans are low-cost, don’t assume that there are no expenses. HR departments don’t always supply up-to-date materials on the available plans, so don’t rely solely on company literature to research choices. Your investment advisor has access to tools that can give you an accurate picture of your plan’s options and help you make a better decision. So, who benefits from a Roth 401(k)? Younger employees who have a longer retirement horizon will have more time to accumulate tax-free earnings in a Roth 401(k) account. And some high-salaried employees will appreciate having both tax-deferred and tax-free money to fund retirement. Employees who want their retirement accounts to pass income tax-free to their heirs may also be attracted to a Roth 401(k).
  • Accessing Your  Roth Account – Both employer and individual Roth accounts are meant to be left untouched until retirement; however, you may take a withdrawal from a Roth IRA at any time. Withdrawals from Roth 401(k)s, like those from traditional 401(k) s, are subject to restrictions while you are working for your employer. But some plans have hardship provisions, and others permit loans up to certain limits.

Required Minimum Distributions

Here are a few tips on required minimum distributions when its time to take them:

  • RMDs generally begin at age 70 ½
  • IRA RMDs can be aggregated
  • 403(b) plan RMDs can be aggregated
  • Qualified plan RMDs (i.e. 401(k) or profit-sharing plans) cannot be aggregated
  • IRA-based plans (SEPs, SIMPLEs, and SARSEPs) always have RMDs at age 70 ½. When inherited, both Roth and traditional IRAs have RMDs
    Designation Roth accounts (i.e. Roth 401(k)s, 402(b)s, and 457(b)s) have RMDs
  • Although you can roll your 401(k) into a traditional IRA, the RMD amount is not eligible for rollover and must be taken from the 401(k) before the rollover. If for some reason, the financial institution allows the RMD to be rolled with the other eligible assets, action must be taken to remove the RMD amount from the receiving IRA. Technically, the RMD amount attributed to the 401(k) was satisfied when the rollover occurred and now represents an ineligible excess contribution in the IRA. The RMD amount for the 401(k) must be removed as a return of excess contribution from the IRA (not a normal distribution) and returned to you.
  • RMDs can be aggregated for certain accounts. For instance, if you have two traditional IRAs and each has an RMD of $1,000, you can withdraw $2,000 from one account to satisfy both RMDs. RMDs for SEP and SIMPLE IRAs can be aggregated with traditional IRAs as well.
  • This same RMD aggregation rule can be applied to multiple 403(b) plans. You cannot, however, take an RMD from a 403(b) plan to satisfy an RMD from an IRA. And when it comes to 401(k)s and other non-IRA accounts, such as profit-sharing plans, you must take a separate RMD from each plan.
  • The rules state that the required beginning date (RBD) for RMDs from a noninherited IRA is April 1 of the year following the year in which the account owner turns age 70½ or retires, whichever is later. The amounts of the RMDs would be based on the year-end value of each account.
  • It is possible to roll the money over from a Roth 401(k) to a Roth IRA to avoid having to take the required distributions at age 72, with some specific guidelines. Check with your trusted advisor for details specific to your circumstances.

We’re Here to Help

Your financial advisor can coordinate efforts with your attorney and tax preparer in creating an estate plan that suits your needs and purposes and helps achieve your financial and personal goals.

We all know there is a lot of misinformation on the web.  That’s why, as part of our GWA Gives© program, we are dedicated to helping people find sound advice. We believe in sharing free material so you have a trusted source to rely upon. We are always happy to answer any questions on making the most of employer-sponsored plans that you might have.  You can reach us at one of our convenient offices listed on the Contact Us page or by filling out the chat form below.

Investments in target-date or target retirement funds are subject to the risks of their underlying holdings. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the workforce. The fund will gradually shift its emphasis from more aggressive investments to more conservative investments based on its respective target date. The performance of an investment in a target date or target retirement fund is not guaranteed at any time, including on or after the target date, and investors may incur a loss. Target date and target retirement funds are based on an estimated retirement age of approximately 65. Investors who choose to retire earlier or later than the target date may wish to consider a fund with an asset allocation more appropriate to their time horizon and risk tolerance.

This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.

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