When you start a new job, you can be totally consumed by all that you need to do in the new position. Worrying about retirement, which may be decades away, can seem to be less of a priority. But since saving and investing for retirement is all about developing good habits, you should want to do just that from Day 1 on the job.
On your first day, you will be asked to choose retirement options that will have long-term implications. Despite the confusion that normally attends the start of a new job, it’s best to keep it cool when it comes to choosing those options.
For the purpose of discussion 403(b) (nonprofit organizations), and 457 (government agencies) retirement plans are similar in structure to a 401(k) plan.
The 401(k) Plan
This is the most common retirement plan offered by employers and one of the most generous. There are some terms and conditions of the plan you will need to investigate and be aware of.
What is the average time you have to be employed to participate? There is generally a delay between the start of your employment and your eligibility to participate in a 401(k) plan. Under federal law, you must be a minimum of 21 years old, and the employer can delay your participation for up to 12 months. That said, many employers offer a shorter waiting period, generally three to six months.
What is a typical employer matching contribution? How much an employer will provide on a matching 401(k) contribution will depend entirely upon the company. The percentage runs the gamut, and there are employers who don’t provide a match at all, particularly if they are small companies. Historically, the typical employer match has been 50% up to the first 6% of salary contributed by the employee, or 3%.
However, according to the Society for Human Resource Management (SHRM), 42% of employers now match employee contributions dollar for dollar, and that is now the most common match.
What are typical vesting requirements for the employer match? “Vesting” refers to the time at which employer matching contributions to your 401(k) plan become your property. Any contributions made by the employer prior to the date specified can see the funds revert to the employer in the event you are terminated or if you leave on your own volition. Any contributions you make to the 401(k) plan are immediately vested, as are any investment earnings accumulated on those contributions.
According to the U.S. Department of Labor, employers have a choice between two different vesting schedules for employer matching contributions:
Cliff vesting — Under this method, employees are 100% vested in the employer matching contributions after three years of service.
Graduated vesting — Under this method, vesting occurs gradually and looks like this:
- 20% vested after two years of service
- 40% vested after three years of service
- 60% vested after four years of service
- 80% vested after five years of service
- 100% vested after six years of service
However, there are different vesting requirements if your plan is an automatic enrollment 401(k) plan. If such a plan requires employer contributions, you’ll be vested in those contributions after just two years. However, if the employer matching contribution under an automatic enrollment 401(k) plan is optional, the employer can revert to one of the two vesting schedules above.
How do you research plans and funds? Your employer should provide you with a 401(k) packet before you even enroll. It should explain the terms of the plan, as well as the investments that are included in it. Some plans offer just a handful of funds, while others may offer hundreds.
In determining which funds you will invest in, you should obtain a copy of the fund prospectus. That will explain what the fund is about and its specific investment portfolio, as well as historical performance data.
If the plan provides a fund family, you can generally go to the website and get summary information on each fund, as well as ask for a prospectus. Often the descriptions will indicate if a particular fund is a good choice for retirement planning, such as a target-date fund.
Retirement Plans Beyond the 401(k) Plan
Your employer may offer retirement plans and options beyond the basic 401(k) plan. Some of those could include:
Traditional pensions. These are also known as defined benefit plans, because they are based on a combination of your years of service and level of compensation in determining what the benefit amount will be. In addition, unlike 401(k) plans and related retirement savings, you don’t contribute money into a traditional pension. That is done for you by your employer.
You don’t have to sign up for a traditional pension plan, either. If the plan is offered by your employer, you are automatically enrolled as a result of being an employee.
Unfortunately, traditional pensions are becoming increasingly rare. Employers began withdrawing such plans after 401(k) plans were introduced in 1974. Though they are still common with government employment, they have become unusual in the private sector.
Roth 401(k) plans. Not all employers offer this option, but the list of the ones who do is growing every year. Like the Roth IRA, your contributions to the plan are not tax-deductible; however, investment earnings that accumulate in the plan do so on a tax-deferred basis. And when you begin withdrawing money from the plan, those distributions can be taken tax free, as long as you’re at least 59½ years old and you have been in the plan for at least five years.
The maximum contribution you can make to a Roth 401(k) is the same as for a regular 401(k): $18,000 per year, or $24,000 if you’re 50 or older. In most cases, both the traditional and the Roth options will be available, and you will have to allocate your contributions between the two, subject to the same overall limit. For example, you can choose to put $12,000 into your traditional 401(k) and $6,000 into the Roth 401(k).
Some employers also offer a matching contribution on a Roth 401(k) plan. However, that contribution must be put into a traditional 401(k) plan, since the employer match will be taxable upon withdrawal, while your own contributions and investment earnings on them will not be.
Profit-sharing plans. Your employer may offer this instead of a 401(k) plan. It can be more generous, but it also has more strings attached. Under a profit-sharing plan, the employer makes contributions to the plan — you don’t. Those contributions are based on a percentage of your salary and can be comprised of cash or company stock, or a combination of both.
Total contributions cannot exceed $53,000 for 2016. So far, so good. But an employer is not required to make contributions to a profit-sharing plan every year. And there is almost always a vesting schedule, requiring you to work a minimum number of years before the contributions are truly yours.
What If Your Employer Doesn’t Offer a Retirement Plan?
There are a number of employers that don’t offer a retirement plan. Though that is not an optimal work arrangement, you might take such a job because either it will advance your career, it will provide you with an opportunity to gain specific training or work experience, or you are unemployed and need a job.
If that’s the case, you have a few options.
Set up a traditional or Roth IRA. You can contribute up to $5,500 per year, or $6,500 if you’re age 50 or older, to either plan. Roth IRA contributions are not tax deductible, but withdrawals from the plan are tax free if you are at least 59½ years old and have participated in the plan for five years or longer. Contributions to a traditional IRA are tax deductible, but you will pay tax on your withdrawals in retirement. And since you are not covered by an employer retirement plan, those contributions will be tax deductible regardless of your income level.
Either plan will enable you to save at least some money toward your retirement while you are not covered by an employer plan. They also offer the added bonus of being able to roll over the funds from a previous employer retirement plan into the IRA.
Save and invest outside of a tax-sheltered retirement plan. You can save money outside a tax-deferred retirement plan by investing money through regular taxable brokerage accounts, mutual funds, bonds and certificates of deposit. Savings are savings; it’s just that these are not tax advantaged.
Press the employer to start a 401(k) plan. If the employer does not offer a 401(k) currently, you may be able to convince them to do so in the future. Once you are on the inside of the company, and especially if you unite with other employees who also want a plan instituted, it may happen.
Consider whether or not you want to stay with that employer on a long-term basis. If the employer will not offer a retirement plan, you may want to seriously consider the job as nothing more than temporary. Once you gain the career experience or training you need, move on as soon as possible to an employer who does offer a plan.
No matter how confusing the new job process may be, preparing for retirement from the get-go is too important to take lightly.