As my National Save for Retirement Week series stretches well beyond that first week, it is time to talk about non-military, employer-sponsored retirement plans. Over the course of a working lifetime, most people have the opportunity to contribute to multiple retirement accounts that are offered through an employer, or as the result of employment. It might be an old-style pension from a post-retirement career, an early start with a high school or college job, a self-employment retirement account, or tiny contributions from a part-time job. Even a little bit here or there can add up over a working lifetime, and concentrated effort can bring big results.
There are two major categories of retirement savings plan: defined benefit plans and defined contribution plans. These are vastly different things and it is important to understand the difference.
Important TermsA defined benefit plan is often called a pension. It is an employer-run plan where the employee does not make any contributions, and the benefit is calculated based upon a set of specific criteria, usually including length of employment and income during employment. It may also include a minimum amount of service to qualify. The employee does not have a specific account and does not have any control over how the plan’s money is handled.
A defined contribution plan is funded by employee, and sometimes employer, contributions to an account specifically for the benefit of that employee. The employee has control over how the funds are invested, and the employee owns all his or her own contributions to the account. The employee becomes owner of the employer contribution on a schedule based upon the terms of the plan. Common employer-organized defined contribution plans include 401(k)s, 403(b)s, and the Thrift Savings Plan. Self-employment defined contribution options include SEP-IRAs, SIMPLE IRAS, and solo 401(k)s.
Vesting is an important concept in employer-sponsored retirement plans. Vesting is the process by which an employee accrues the rights to employer-provided assets, typically including the employer contributions to a defined contribution plan, or eligibility for a defined benefit plan. Most employers do not make all their contributions available to the employee immediately, to entice the employee to remain with the company.
Here’s a vesting example: My friend’s company contributes 5% of her salary to a defined contribution plan each year. However, that money doesn’t become “hers” until two years after it is contributed, until she has worked for the company for five years. Her first year, her company contributed 5% of her salary to her 401(k). If she leaves the company before the two-year vesting period ends, she forfeits the company contribution that she earned. However, if she leaves the company after the two-year vesting period for the first year’s employer contributions, that money is hers (within her retirement account.) The same is true of her second year, and this continues until she reaches the magic five-year cliff. At that time, all previous employer contributions become hers, and all future subsequent employer contributions are immediately vested to her with no wait.
You Need To ParticipateNow that I’ve rambled on about the type of retirement accounts that might be available to you, we get to the most important part of this subject as it pertains to you and your retirement savings bucket: whenever you are able to contribute to one of these plans, participate and maximize your contributions. A modern retirement plan requires multiple sources of retirement income, and the more variety you have in your retirement bucket, the more stable your plan. Most US workers will not remain in any job long enough to accrue a defined benefit pension, which makes it even more important that you contribute to whatever defined contribution plans come with whatever job you have.
When you get a new job, it is easy to push off enrolling in retirement savings plans, and this is doubly true for part-time jobs or when you anticipate being at the job only a short time. I’ve done this, and I regret it. A little savings from this job and a little savings from that job can add up significantly over time.
Some people assume that they are automatically enrolled in their employer’s retirement plan. While automatic enrollment has jumped in the last few years, 40% of companies still do not automatically enroll their employees in their retirement plans. If you think that you’ve been automatically enrolled, check to be sure you’re right.
One last thing to consider is that you might actually go out of your way to make opportunities for great retirement savings. When job hunting, compare the available retirement savings plans. Some are signficantly better than others. Heck, even some part-time jobs have some pretty sweet retirement savings options (I’m thinking I need to find a job at Trader Joes!) If you have any kind of self-employment income, set up a SEP or SIMPLE IRA or a Solo 401(k) to sock that money away. Heck, if you’re dedicated to filling your retirement bucket, you might consider setting up a small business for the express purpose of saving the income.
In case I haven’t been clear, the major point of this post is that most of us have many opportunities to save for retirement. Maximizing your retirement savings will provide you with more retirement security and better options. And that’s a good thing.