Employer Plans Can Offer the Foundation of a Comfortable Retirement
Established by Congress in 2006, National Retirement Security Week is designed to elevate public knowledge about retirement savings and to encourage employees to save and participate in their employer-sponsored retirement plans. What better time to review the benefits of your retirement plan and determine if you're making the most of them?
Whether you have a 401(k), 403(b), or governmental 457(b) plan, contributing helps benefit your tax situation. If you make traditional (i.e., non-Roth) contributions to your plan, they are deducted from your pay before federal (and most state) income taxes are calculated. This reduces the amount of income tax you pay now. Moreover, you don't pay income taxes on those contributions — or any returns you earn on them — until you withdraw money from the plan, ideally when you are retired and possibly in a lower tax bracket.
If your plan offers a Roth account and you take advantage of this opportunity, you don't receive an immediate tax benefit for participation, but you could receive a significant tax advantage down the road. That's because qualified withdrawals from a Roth account are tax-free at the federal and, in many cases, state level.
A withdrawal from a Roth account is qualified if it's made after a five-year holding period (which starts on January 1 of the year you make your first contribution) and one of the following conditions applies:
- You reach age 59½ (55 if separated from service; 50 for qualified public safety employees)
- You become disabled
- You die, and your heirs receive the distribution
So should you contribute to a traditional account, a Roth account, or both? The answer depends on your personal situation. If you think you'll be in a similar or higher tax bracket when you retire, you may find a Roth account appealing for its tax-free retirement income advantages. On the other hand, if you think you'll be in a lower tax bracket in retirement, then a traditional account may be more appropriate to help reduce your tax bill now. Of course, you could also divide your contributions between the two types of accounts to strive for both benefits, provided you don't exceed the annual maximum contribution amount allowed ($19,500 in 2020; $26,000 if you're age 50 or older).1
Keep in mind that employer plans were created specifically to help Americans save for retirement. For that reason, rules were also established to discourage participants from taking money out early. With certain exceptions, withdrawals from traditional (non-Roth) accounts and nonqualified withdrawals from Roth accounts prior to reaching age 59½ are subject to regular income taxes and a 10% penalty tax.
Employers are not required to contribute to employee accounts, but many do through matching or discretionary contributions. With a matching contribution, your employer can match your traditional pre-tax contributions, your after-tax Roth contributions, or both (however, all matching contributions will go into your traditional, tax-deferred account). Most match programs are based on a certain formula — for example, 50% of the first 6% of your salary that you contribute.
If your plan offers a matching program, be sure to contribute enough to take maximum advantage of it. Neglecting to contribute the required amount is essentially turning down free money.
Your employer may also offer discretionary contributions, which often take the form of profit-sharing contributions. These amounts generally go into your traditional account once per year, and typically vary from year to year.
Employer contributions are often subject to a vesting schedule. That means you earn the right to those contributions (and the earnings on them) over a period of time. Keep in mind that you are always fully vested in your own contributions and the earnings on them.
Review your strategy now
While most people understand that their employer-sponsored retirement plan is a key to preparing adequately for the day when the regular paychecks stop, they may not take the time to review their plan's benefits and ensure they're taking maximum advantage of them. National Retirement Security Week provides a perfect opportunity to review your plan materials, understand its features, and determine if any changes may be warranted.
1 Special catch-up rules may apply to certain participants in 403(b) or 457(b) plans.
The accompanying pages have been developed by an independent third party. Commonwealth Financial Network is not responsible for their content and does not guarantee their accuracy or completeness, and they should not be relied upon as such. These materials are general in nature and do not address your specific situation. For your specific investment needs, please discuss your individual circumstances with your representative. Commonwealth does not provide tax or legal advice, and nothing in the accompanying pages should be construed as specific tax or legal advice. Securities offered through Commonwealth Financial Network, Member FINRA/SIPC.
About the Author
I am an avid gardener, a trait I inherited from my Sicilian grandfather. Herb, cucumber, spinach, lettuce, and tomato varietals fill my yard each Summer. I am the only person in my neighborhood bold enough to plant vegetables in the front yard (best sun). Get me talking about growing tomatoes and the conversation might never end. The garden is a special place for my two daughters and me. We chase each other around the eggplants, search for cucumbers hiding under the vine, dig for worms, and pluck tomatoes just as they show a tint of ripeness.