Most people don’t start their careers by starting their own business. Usually we start as an employee for a company, which is where we should be focused on saving in the beginning. According to our investment hierarchy, this is the second step in our journey after we establish cash flow. Most employers offer employer sponsored retirement plans which we can use to save for our retirement. Whether you have access to a 401(k), 403(b), TSP or a pension plan, you should start contributing as soon as you can. The sooner you start contributing to your retirement, the longer your contributions will grow. The longer your contributions your contributions grow, the more money you will have in retirement. With more money in retirement, you will be able to do just about anything you want. Here are some of the most common employer sponsored retirement plans and their use cases.
The Most Common : 401(k)
There are two different types of 401(k)s. These are traditional 401(k)s and Roth 401(k)s. Both plans are sponsored by private employers so their employees can contribute to their retirement. Traditional 401(k)s are pre-tax contributions and funds are taxed when they are withdrawn from the account. Roth 401(k)s are funded with post-tax contributions and therefor do not need to be taxed in retirement, which allows you to withdraw your gains tax free.
Each type of 401(k) has its own benefits and downsides. The decision on which plan to use depends on whether you believe you will have a higher tax burden now or in retirement. This is a question you should ask your CPA or financial planner. Usually the more time you have on your side, the more likely you should be contributing to a Roth 401(k). Gains are tax free in Roth 401(k)s and the account has a longer timeframe to grow.
Most employers will offer a form of match on their 401(k). Companies that I have been at have contributed anywhere from 3 to 8% match. The first step to take in saving for retirement is to get the company match that you are able to. It is essentially free money for investing in your retirement future. This is a great way to get started with employer sponsored retirement plans.
Employer Sponsored Retirement Plans for Public Employees : 403(b)s
If you are a public sector employee, than you will have access to a 403(b) vs a 401(k) like a private sector employee. They are very similar products in their offerings. Like a 401(k) a 403(b) has a contribution limit of $19,500 in 2021 with a combined employee and employer contribution of $58,000. They both offer catch up contributions for those over the age of 50 of $6,500.
You will also be stipulated to the same requirement of not access the account until you are 59 1/2. This means these are both longer term retirement accounts that will provide for you as you age. The 403(b) has a special catch up provision if you have 15 years or more of service with certain nonprofit and government agencies. This allows you to contribute an additional $3,000 a year up to a lifetime limit of $15,000.
The downside of 403(b)s is the rigidity of their investments. They only allow fixed and variable contracts and mutual funds. You are not able to invest in individual securities or real estate investment trusts. Regardless, if you have access to a 403(b) with matching contributions the best bet is to contribute at least the match.
Thrift Savings Plans : Retirement Plans for Federal Employees
When you are employed by the federal government or a member of the armed forces you will have access to a Thrift Savings Plan or TSP. These plans are very similar in tax benefits as a 401(k) for the private sector. The biggest difference is the set of investment vehicles that you have within the plan.
TSP’s offer six different investment funds, These options include L, specific life-cycle funds, F, fixed-income fund, G, government securities fund, C, common-stock index fund, S, small-cap index fund and I, international stock fund. These each try to mimic their respective benchmark index with the exception of the L funds. L funds use a mix of the 5 other funds based off of the timeline to retirement. If you are interested in their performance you can head over to the link above.
The Unicorn of Employer Sponsored Retirement Plans : Pensions
Odds are that you have heard someone mentioned pensions before but they are quickly becoming a retirement account of the past. There are two main types of pensions, defined-benefit and defined-contribution. A defined-benefit pension works by the company’s pension plan agreeing to pay you a set amount per year when you were retired. The company usually set the benefit based off of years of service and a percentage of your salary. Defined-contribution’s worked by the company contributing a set amount of money to your retirement fund every year based off of your time with the company. Both of these are becoming increasingly rare.
As people begin living longer and having longer retirements, defined-benefit pensions have increased the strain on their fund’s resources. This is one of the fears regarding social security in the future. Investment funds have been comingled to pay for current pensions which is leading to our current predicament. Pension plans were designed to pool everyone’s assets together so there are perpetual returns to pay out these benefits. Unfortunately, due to mismanagement among other factors, this hasn’t been the case. Hopefully this will become a problem of the past and fund managers can get the pensions under control. The likelihood seems slim either way.
Investment Hierarchy Second Tier
Employer sponsored retirement plans should be the first step in your investment journey, but not the last. As you begin working and have created monthly cash flow for yourself, make sure you get any employer match towards your retirement. There are tax advantages that these programs offer to help you save for the future. As you begin to get more familiar with investing and saving for retirement, that’s when we can move on to the next step of individual retirement accounts.
Have you participated in any of these employer sponsored retirement plans? Let me know in the comments below what you thought of them!
As always don’t forget to follow me on twitter and we can always continue the conversation there.