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Employer-Sponsored Retirement Planning

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An employer-sponsored retirement plan is a workplace benefit offered by some companies to help provide workers with income in retirement. Employer-sponsored plans take different forms, but they fit primarily into two categories:

Employer-sponsored retirement plans are very common. In March 2020, the Bureau of Labor Statistics reported that 67% of nonunion workers and 94% of union workers had access to them. However, there are pros and cons workers should consider before using a workplace retirement plan to save for their later years.

Types of employer-sponsored retirement plans

Employers determine the type of retirement savings plan they want to offer. Workers often, but not always, can opt in or out. Some of the most common types of employer-sponsored retirement plans include the following.

Qualified retirement plans

Qualified retirement plans are tax-advantaged retirement plans subject to the 1974 Employee Retirement Income Security Act (ERISA) rules, as well as IRS guidelines. ERISA requirements are extensive. Plans are subject to minimum participation requirements, annual contribution limits, and vesting requirements.

Employers and employees can contribute to them with pre-tax dollars, but employers are subject to reporting, disclosure, and funding rules.

Non-qualified retirement plans

Non-qualified retirement plans are employer-sponsored retirement plans that do not have to meet ERISA guidelines. These plans are often provided to highly compensated employees as a benefit.

Non-qualified plans aren’t subject to annual contribution limits, and there are far fewer reporting requirements. Unlike qualified plans, they’re funded by employers with after-tax dollars. Employers can limit participation to select employees.

Defined benefit plan

defined benefit plan is an employer-sponsored retirement plan that guarantees an employee will receive a certain amount of money in retirement. Also called pension plans, defined benefit plans require employers to assume investment risks and responsibilities.

The amount of money an employee receives is determined by a formula usually based on years of service and salary. Benefits can take the form of fixed monthly annuity payments, or employees may receive a single lump sum payment. In many cases, if an employee dies, his or her surviving spouse is entitled to receive benefits from the plan.

Defined contribution plan

Defined contribution plans are more common than defined benefit plans, especially among private-sector workers. Under most of these plans, including 401(k)s403(b)s, and SIMPLE IRAs, employees are provided with the opportunity to defer a portion of their salary with pre-tax dollars but aren’t required to do so.

Employers can make voluntary contributions for a 401(k) or a 403(b). In the case of a SIMPLE IRA, employers must make mandatory contributions based on a preset formula. A SEP IRA is another type of defined contribution plan, but only employers can contribute to it.

With defined contribution plans, employees shoulder the investment risk and are largely responsible for ensuring their own retirement security. Employees are not guaranteed any minimum retirement income, and account balances fluctuate depending on changes in the value of investments.

Vesting retirement plans

Vesting retirement plans

Some workplace retirement plans offer employees ownership only after they fulfill certain requirements, such as working for a certain number of years.

In defined contribution plans, worker contributions are always 100% vested, meaning the employee owns them right away. However, if employers make matching contributions, there may be a vesting schedule that either transfers ownership to the employee slowly over time (on a graded vesting schedule) or all at once after the employee fulfills a specific requirement (on a cliff vesting schedule).

Generally, employees must be fully vested and have 100% ownership of employer contributions after:

  • Three years under a cliff vesting schedule.
  • Six years under a graded schedule.

Vesting is also common in defined benefit plans where employers guarantee a certain amount of retirement income. Employers must allow workers to be 100% vested in employer-funded benefits within:

  • Five years under a cliff vesting schedule.
  • Seven years under a graded vesting schedule.

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