Investing for Retirement -- Use
Employer's Plan
It is important to personally save for retirement. However,
one in three workers report they have not started. A good way
to save for retirement is to take advantage of retirement options
through your employment, says Pat Swanson, CFP® and families
specialist with Iowa State University (ISU) Extension’s
Invest Wisely Project (www.extension.iastate.edu/investwisely).
There are several types of plans available.
“Traditionally employer-provided pensions have been defined
benefit plans in which the employer promises a benefit based
on a formula that considers the employee’s years of service
and salary,” Swanson says. “However, these traditional
pensions are becoming less common. Instead employers are offering
defined contribution plans. A defined contribution plan provides
an individual account for each participant. The benefit at retirement
depends on the amount contributed and the returns earned by the
investments in the account.”
A 401(k) plan is the most common defined contribution plan;
it is available to employees of many private companies. Other
defined contribution plans are 403(b) plans available to public
school teachers and employees of nonprofit organizations and
457 plans for state and municipal workers. These plans get their
names from the sections of the Internal Revenue Code that authorize
them.
Defined contribution plans also are known as salary reduction
or tax deferral plans, according to Swanson. Employee contributions
to the plans are pre-tax contributions. “You save on your
tax bill and invest for retirement at the same time. The earnings
on the growth on your investments in the plan are not taxed until
you withdraw money in your retirement.”
To illustrate the impact of tax deferral, Swanson describes
two 30-year-old individuals who both have $4,000 available to
invest each year until age 68. One individual would have the
full $4,000 to invest if he contributes to his 401(k) plan each
year while the other individual would only have $2,800 if he
invests with after-tax dollars (assuming a 30 percent federal
and state tax rate). Assuming both earn an annual average return
of 9 percent, at age 68 the individual who invested through a
salary deferral plan such as a 401(k) would have accumulated
more than $1.13 million while the other would have slightly more
than $790,000.
The maximum contribution allowed by law is $15,500 annually
($20,500 if age 50 or older) but the company plan may specify
a maximum contribution that is less than this. Some plans automatically
enroll employees in the plan and deduct part of the employee’s
salary into the plan unless an employee opts out. The company
may match your contribution in whole or in part. For example,
an employer may add 50 cents for every dollar you contribute
up to a maximum amount. “It is a good strategy to take
advantage of this employer match,” Swanson says.
A defined contribution plan gives the employee choices as to
how the money is invested. These typically are mutual funds including
stock, bond and money market funds. “The amount of money
in your defined contribution account at retirement will depend
on your investment choices and the returns these have made over
the years. It is important to consider your risk tolerance, your
return needs, and time horizon when making your selections,” Swanson
concludes.
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The ISU Extension Invest Wisely
Project provides a series of newspaper, radio, and web resources
for investors. It is funded by a grant from the Investor
Protection Trust (IPT). The IPT is a nonprofit organization
devoted to investor education. Since 1993 the IPT has
worked with the States to provide the independent, objective
investor education needed by all Americans to make informed
investment decisions. www.investorprotection.org.
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