Many employers provide several benefits to their employees as an incentive to attract and retain the talent. They generally include paid vacations, sick leave, health insurance, retirement benefits, group life, disability benefits, etc. Employers typically require employees to sign up for them annually (benefit enrollment). Some of these plans offer extended benefits which you must take full advantage of. Given the large number of people covered, employers get reduced negotiated rates. For example an employer may offer a group life insurance for a certain minimum amount and you may be able to take the advantage of the reduced premium to obtain additional coverage. Among these benefits, health insurance and retirement benefits are most important. Other benefits may include reduced ticket prices for various events and discounts on auto and homeowner insurance.

All employer provided retirement plans are governed by Department of Labor under ERISA (Employee Retirement Security Act). ERISA does not require employers to set up retirement plans. But if they set up a retirement plan to attract/retain talent and get tax benefits as a result, then it requires employers to follow certain operational standards. These standards include ensuring that the plan is benefitting all eligible employees fairly. Some employers set up 401(k) plans allowing both the employer and the employees to contribute, or just employees to contribute. Show details

Some large employers still have the pension plans under which employers are obligated to set aside certain minimum funds each year in the plan to pay certain retirement benefits to its retired workers. Some employers have also been offering profit sharing plans under the charter of 401(k). ERISA permits different types of retirement plans based on the size of employer and different forms of contribution by employer (cash, stock) to these plans. Since these retirement plans qualify for tax deferral to employees (i.e. no federal taxes on allowable contribution until money is withdrawn from underlying account during retirement) and tax deduction for employers, they are also called 'Qualified Plans'. ERISA requirements ensure that retirement plan benefits are fairly shared among the employees of a firm and they are not discriminatory, favoring owners and senior employees. All employer sponsored qualified plans are administered by a 3rd party, a financial institution, to make sure pension funds aren't accessible to employers for their own use. The employer is required to provide a 'summary plan description' or SPD to employees. A summary plan description provides the information on: Show details

  • Eligibility criteria for being covered under the plan. Generally, it is 21 years of age and 1 year of service.
  • Participation
  • Vesting schedule: This specifies the schedule of how you will gain the ownership of your employer contribution to your retirement plan. Note that in most cases employer contribution requires a matching contribution by you. Generally, the employer contribution is fully vested over a 5 year period (20% each year). After the vesting period, any contribution made by the employer is immediately vested. If you leave your employer during the vesting period, you will only get that portion of employer contribution which has been vested.
  • Loan Provision: Some plans allow plan participants to take loans against their accumulated retirement benefits for certain activities. Terms and amount of loans are described in the plan document.

Retirement Plans:
In terms of qualified plans (employer offered), there are about 10 retirement plans which can be organized in two different ways. Show details

They could be categorized as defined benefit (DB) plans or defined contribution (DC) plans based on whether the plan provides a defined retirement benefit or involves a defined contribution from employer and/or employee. The other way to slice these plans is as profit sharing plans and pension plans. Pension plans involve legal promise from the employer in terms of providing a specified benefit (DB) or a specified contribution (DC). The benefit from a defined benefit plan at normal retirement is limited to the lesser of 100% of the participant’s average compensation of 3 highest consecutive years of compensation or $230,000. The maximum employer contribution to a DC plan in a given year is limited to the lesser of 100% employee compensation, or $58,000.

Profit Sharing Plans:

In a profit sharing plan, contributions by both the employer and employee are to individual employee account and are discretionary. However, IRS requires employer contributions to be substantial and recurring. No wonder profit sharing plans are most commonly offered by employers. The employer contribution to the plan is either a percent of company profits or a percent of the employee's compensation.
Here is a list of all qualified plans. Show details

#Plan NameProfit Sharing or Pension Plan?DB or DC?
1. Profit Sharing Plan Profit Sharing DC
2. Sock Bonus Plan Profit Sharing DC
3. Employee Stock Ownership Plan (ESOP) Profit Sharing DC
4. 401(K) Plans Profit Sharing DC
5. Defined Benefit Pension DB
6. Cash Balance Pension DB
7. Money Purchase Pension Pension DC
8. Target Benefit Pension
9. Thrift Plans Profit Sharing DC
10. SIMPLE 401(k) Profit Sharing DC

Details of these plans and other tax advantaged plans is available at Saving Plans.

This is the most popular retirement plan among private employers. It is a defined contribution plan that allows both the employer and the employees to contribute. The maximum annual employee contribution (pre-tax) is limited to $22,500. Additionally, if you are age 50 years or over, you can contribute an additional $7,500. Show details

The employer contribution could be contingent upon a match from the participant and has the same upper limit for all DC plans. Working with the plan administrator (a financial services company), the employer offers multiple investments to choose from. In general available investment options are different types of mutual funds. The participant in consultation is with a financial adviser is expected to construct a diversified portfolio of investment choices with an allocation mix appropriate to his/her risk tolerance and time to retire. As much as it is important to regularly contribute your maximum permissible amount to a diversified portfolio, it is also important to periodically rebalance the portfolio. This plan offers an important benefit of in service withdrawals by employees in case of hardship. Other than retirement (age 59 ½), distribution from the plan can be taken in the event of death, disability, and separation from service. Distribution simply means you have access to funds but if you withdraw funds you will be subjected to income tax and potentially an early withdrawal penalty too. In addition they also have a loan provision. The loan amount is limited to the lower of 50% of account balance and $50,000.

ESOPs are profit sharing plans in which participant benefit is in the form of the stock of the employing company. A participant can sell the stock received to buy other securities in order to diversify the portfolio. But similar to other qualified plans, you must pay taxes when you withdraw funds during retirement. Annual contribution limit of defined contribution plans applies to ESOPs as well.

Stock bonus plan is like a profit sharing plan except that the benefits are generally not distributed in cash but in the form of employer stock. For securities that are not traded in the stock market, the employee may sell the stock back to employer to get cash via a put option. Employees are generally not allowed to contribute.

This is a relatively new plan. In this plan an employee can make elective after tax contributions. The biggest benefit in this plan is that your contribution grows tax free i.e. during retirement you don’t pay any federal taxes for the entire amount withdrawn. You are also not taxed on your contribution even if you withdraw prior to retirement. With the long term outlook of higher income tax rates, contributing to a Roth 401(k) plan may not be a bad idea. The employee contribution limit is $22,500. The distribution rules follow the rules of Roth IRA except for the “first time homebuyer” withdrawal provision.

  • Estimate your retirement needs
  • If your employer offers a tax advantaged plan, contribute to the best of your ability
  • Invest in a diversified portfolio and rebalance the allocations either every year, or every other year.
  • For your employer sponsored plans e.g. a 401(k), make sure you take full advantage of your employer’s contribution by contributing at least the match. It is really like leaving money on table.
  • Qualified retirement plans are protected from creditors i.e. your creditors can not go after you qualified retirement account savings.
  • If you are a 401(k) plan participant, make sure you elect the contribution that is lower of highest amount you can afford and the maximum allowed by the plan. It might stretch your budget but will be worth the agony.
  • You may feel tempted to take a loan from your 401(k) plan. But this is not a recommended practice. Because you not only have to pay back the loan amount with interest, you also miss out on the gain of investment during this period. If you don’t return, you need to pay income tax on the amount withdrawn and an additional 10% early withdrawal penalty.