How Do Employer Retirement Plans Work?

A defined benefit plan which promises workers a specific amount of retirement income. Defined benefit plans also are known as pension plans.

A defined contribution plan doesn’t guarantee any retirement income but instead allows employees to save for their pension, often with help from the employer.

Qualified retirement plans. The Employee Retirement Income Security Act (ERISA) is a crucial reference point for fundamental ideas. These plans must conform to ERISA’s requirements to maintain their tax-favored status. Minimum participation, annual contribution caps, and vesting requirements apply to the plans. Employers and employees can contribute to them with pre-tax dollars, but employers are subject to reporting, disclosure, and funding rules.

A non-qualified retirement plan is a tax-deferred, employer-sponsored retirement plan that falls outside ERISA guidelines. For example, non-qualified plans aren’t subject to annual contribution limits, and there are fewer reporting requirements.

Vesting retirement plans means that each employee will annually vest, or own, a certain percentage of their account in the plan. Employees who are 100% vested in their account balance own all of the money in their account, and their employer is not permitted to forfeit it or take it away for any reason.

• Pension plans

When you retire from an organization that provides a traditional pension, you generally have two income choices: a pension annuity or a lump-sum distribution.

With an annuity, you receive income each month for the rest of your life or the life of another person, usually but not necessarily your spouse. When you retire, your employer calculates the amount you’ll receive based on factors including your age, your final salary, and the number of years you’ve worked for the organization. Income taxes are withheld from each check. If you choose a lump sum, your employer calculates the amount you’ll receive and transfers the money to your designated account. If it’s a cash account, income taxes are withheld, whether or not you plan to move the money into an IRA. If you roll over the amount directly to a tax-deferred IRA, income taxes are not due until you withdraw from that account.

• Defined contribution plans

If you’re part of a defined contribution plan, such as a 401(k), 403(b), 457, or thrift savings plan (TSP), you have several choices for handling your plan assets.

They always include (1) leaving your money in the plan, where you may be able to convert it to a pension annuity or take systematic withdrawals, (2) rolling over to an IRA, or (3) taking a lump sum.

Unlike a defined benefit pension, which pays your retirement income out of your employer’s pension fund, retirement income from a defined contribution plan comes from assets in your name.

What you receive depends on how much, how long it was invested, and how the investments performed. Generally, the accumulated assets are sold when you choose an income option, and the value becomes the principal used to purchase an annuity contract, transferred to an IRA, or paid out as a lump sum.

What are the critical factors to consider when making your decision?

While you don’t have to decide until you’re ready to stop working, making the best choice is critical. You have to consider your age and health, what you want to provide for your family, and what other sources of income you’ll have.

For example, if you’re in poor health and concerned about providing for your spouse, you might choose a joint and survivor pension annuity that will continue to pay while either of you is alive. On the other hand, if your spouse has a good pension from their employer or is seriously ill, you might choose a single-life annuity that will provide a more significant amount for you each month than a joint annuity would. In many cases, this option requires your spouse’s written, notarized consent.

Or, if it’s your employer’s financial health you’re concerned about, you may decide to take your money out of the plan and invest it elsewhere.

It’s crucial for people whose employers offer retirement plans to weigh the benefits and drawbacks of participating in a workplace plan versus using alternative retirement accounts, such as individual retirement accounts (IRAs).

Here are some of the most significant advantages of joining an employer-sponsored retirement plan. 

• Some plans provide guaranteed income.
• Employers frequently offer a company match on your contributions for plans without defined benefits.
• In some companies, investing is often automatic unless employees choose to opt-out.

But there are also drawbacks. 

• Some plans have significant fees.
• You may have to work a certain amount of time to become eligible.
• You have less investment flexibility.

Where can you get advice?

You’re likely to be more confident about making pension decisions if you work with an experienced professional who can answer your questions and help you analyze different routes to your goals. Since many of these choices are irrevocable, you’ll want to weigh the alternatives carefully.

Your employer may have specialists on staff who know the ins and outs of your plan and how other employees have handled the decisions you’re facing. You might ask your other professional advisers for a referral. But don’t feel you have to rush into working with someone. You’ll want to check their professional credentials and resolve to your satisfaction that the advice you’re being given is both knowledgeable and impartial.

Before you can begin taking income or roll over your assets, your account has to be valued to determine what it is worth. Every plan values accounts on a regular schedule, but no plan does a separate valuation for account holders who want to move their money or begin distributions. In addition, a 401(k) or similar plan has the right to hold your money for up to 60 days after valuation. Not every plan does, but that could be the case. 

It might be more straightforward than most people realize to start a retirement plan. Additionally, many retirement plans offer tax advantages to both employers and employees.

How Do Employer Retirement Plans Work? by Inna Rosputnia

Wishing you a great week!