07 Apr Retirement Plans

Are you taking advantage of the retirement plan options offered by your employer? If not, you might want to reconsider and take an active role in investing for your future. Also, deferring a portion of your income for retirement reduces your taxable income for federal income tax. Sounds like a great incentive to me!

Types of Plans

There are several types of retirement plans you can take advantage of through your employer. The plans are considered to be a perk of employment because employers are not required to offer them. To jump start your personal research, let’s proceed with a high level overview about some of the plans offered.

401(k) – Most common employer sponsored plan and the maximum amount you can contribute is $19,500 in 2021. The contribution maximum amount may vary from year to year due to periodic adjustments for inflation. Some employers may match 3-6% of your contribution and it does not count towards the maximum amount limit for employees. However, it does count towards the overall contribution limit amount of $58,000 for the employee and employer portions combined in 2021.

403(b) – A plan designed for employees of tax exempt organizations such as colleges and universities, religious organizations, public charities and public schools. Like the 401(k) plan, the maximum amount an employee can contribute is $19,500 in 2021 and the amount may vary from year to year. The employer has the option to match the contributions but many choose not to do so.

457(b) – A plan designed for employees of cities, counties, states, towns, special governmental districts and certain tax exempt organizations. The maximum contribution amount is $19,500 in 2021 and the amount may vary from year to year as well. Some employers may match the contributions made by the employees. This plan offers an attractive feature for early withdrawals when compared to the 401(k) and 403(b) plans. If an employee decides to retire before 59 1/2 years old and need to withdraw their funds from the account, the 10% tax penalty will not apply.

Pension – The less common employer sponsored plan offered. The employer funds the plan which guarantees a specific retirement benefit for the life of the employee based on the amount contributed and the years of service with the company. There are some plans that require the employees to contribute as well. However, the employees do not control how the funds are invested and they do not assume the risk of the investment.

Roth plans – The 401(k), 403(b), and 457(b) plans may contain a Roth option. If an employee chooses this option, the retirement contributions will be subject to federal income tax when they are withheld. When the funds are disbursed at retirement, they will not be subject to federal income tax.

Catch up contributions

The Economic Growth and Tax Relief Reconciliation Act of 2001 created the catch up contribution option to assist older employees with saving more for retirement. If an employee turns 50 before the end of the plan year, an extra $6,500 can be contributed to the 401(k), 403(b), and 457(b) plans. The maximum contribution amount will increase from $19,500 to $26,000 in 2021.

Tax withholding

When retirement contributions are made, they are only subject to Social Security and Medicare taxes, also known as FICA. Federal income tax is not withheld and the contribution is not reported on the W-2 form as income. When the funds are disbursed at retirement, federal income tax will be assessed unless the Roth plan option was chosen.

Recap

Taking advantage of the plans offered through your employer is a great way to start saving for retirement. Some of the most common plans offered are 401(k), 403(b), and 457(b). There are some employers who offer pension plans but it’s not as common as the other traditional plans. The Roth plan option allows you to pay federal income tax on the contributions when they are withheld verses paying it when the funds are disbursed at retirement. Catch up contributions were created to assist older employees who may have started saving for retirement late. It’s a great option if you can afford to contribute an extra $6,500 during the plan year. All retirement contributions are subject to Social Security and Medicare taxes when they are withheld.