Many of us do not under stand retirement plans and therefore do not participate in them. This writing will clarify how to identify some of the plans an employer may offer. This writing will tell us why to invest into employer based plans, and some rules that are associated with them.
Depending on whom you ask, a Financial Advisor or a Broker, you will get conflicting stories on how to invest for retirement. A Broker will try to sell you on trading. Argument for this is the potential for larger returns on investments and your investments not being eroded by plan administrative fees. These investments are not insured by the government and are considered to be risky.
The Financial Advisor will tell you to go with the employer based retirement plans before trying to sell their services. The reason for this is the Tax advantage not to mention security in diversification and some employers will contribute to your retirement plan.
Since the most secure and most popular is employer based plans we will discuss them. Employer based plans come in two flavors. Defined Benefits Plan and Defined Contribution Plan. The Defined Benefits Plan being the simplest to manage, and the Defined Contribution Plan the more complex in design.
Defined Benefit Plan simply pays out a lump sum upon retirement or provides a guaranteed monthly benefit for a given period. It is also know as a Traditional Pension Plan. Usually the employer funds the plan and pays for the management fees of the Plan. There are exceptions where employees may contribute to the plan. The amount paid out is commonly base on a formula. Most common calculation is based on the last highest earned wages and time severed with the organization. Numerous variations of calculation are done on these two variables. This type of plan in most cases is insured by the federal government making it a secure plan.
Defined Contribution Plan is a bit more complicated and does not guarantee a specific amount of payout for retirement. The most common types are: 401(K), 403(B), 457(B), Simplified employee plan (SEP), Employee stock Ownership plan (ESOP), Profit Sharing Plan and Simple IRA. The plan most people are aware of is the 401(K) plan. Although not common, employers may have more than one of these plans and employees may be enrolled into more than one plan. Employer in some cases will match employee contribution up to a certain point.
The down side of defined benefit plan is that it is likely to be optional and taxes will be taken out when you begin to with draw from the account. Workers will be given the option to enroll or let it go by when they become eligible. It is important that the employee immediately upon eligibility enroll in a retirement account to gain the benefit from a plan. Time lost is interest lost which equates to money lost.
If the plan is under pre tax dollars (most of them are) you gain tax advantages from the plan. The contributions are made before payroll taxes are taken out so you are taxed at a lower income bracket. Any money gained remains tax free until you start to draw from the account. This is important because it allows your nest egg to grow faster. The growth however is based on the performance of investment options selected under the plan.
There are vesting rules tied to retirement plans. Just as there are options to invest there are options for employers to select vesting rules. Vesting means you have to be enrolled in a plan for a certain number of years before you can draw out any funds that are employer contributed. If you are fully vested anything in the account is yours with only Uncle Sam the tax man to reduce your withdrawal.
In summary employer base plans are the most effective way to save for retirement. The employer can have one or more plans to select or enroll into. Employer based plans come in two varieties Defined Benefit and Defined Contribution Plan. The employee can gain tax advantages from enrolling into a plan.
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