![]() ![]() If you make $100,000 a year, your employer will match annual contributions up to $6,000. You are doubling your money, and your employer is building a happy workforce.Ī common example of such a matching agreement is for the employer to match 100% of all contributions up to 6% of an employee’s income. If your employer promises to match all 401(k) contributions up to 5% of your income, and you contribute that amount (5% of your income) every month, your employer will match you dollar for dollar, every month. Matching is a very transparent process: for every dollar you put into your 401(k), your employer also puts in a dollar, up to a certain amount or percentage of your income. One of the ways it did so was by giving employers the option to “match” employee contributions. The 401(k) created an entirely new system, with more flexibility for both employer and employee. In 1978, when the law authorizing the creation of the 401(k) was passed, employers commonly attracted and retained talent by offering a secure retirement through a pension (a type of a defined benefit plan). Why Employers Offer 401(k)s Photo credit: © iStock/Marvin Samuel Tolentino Pineda That doesn’t mean such plans can’t be just as effective, however, and employers often sweeten the deal by making contributions of their own, straight into your account. In a defined contribution plan (unlike in a defined benefit plan), there are no guarantees about the income you’ll receive in retirement. The money that doesn't go to the employee's take-home pay gradually accumulates, the balance earns interest from investments, and by the time retirement rolls around, it’s grown into a substantial nest egg for the retiree. Often, the employee chooses to send a fixed percentage of monthly income to the account, and these contributions are automatically withdrawn, directly from her paycheck - no effort required. What Is a Defined Contribution Plan?Ī defined contribution plan is any retirement plan to which an employee or employer regularly contributes some amount. In what cases is it most useful? Are there hidden costs? And, most importantly, how does the dang thing work? Before we try to answer that question, however, let’s make sure we understand the basics.ĭo you need help planning for your retirement? Find a financial advisor who serves your area with our free online matching tool. You may even remember some of the rules regarding early withdrawals and roll-overs - or maybe not.įor anyone who is building a retirement strategy that prominently features a 401(k), it’s important to have a deeper understanding of the plan, both its advantages and disadvantages. You probably know, for example, that a 401(k) is a type of “defined contribution plan,” and you are probably aware that it receives special tax treatment from the IRS. If you’ve thought for even a few minutes about saving for retirement, chances are you have some familiarity with the 401(k) savings plan. Tax calculations are based on the tax filing calendar, therefore calculations prior to April are based on Paid on withdrawal at the tax rate applicable at the time of withdrawal. Taxes: Contributions to a 401(k) are made pre-tax, investments grow tax-deferred and income taxes are Rollovers: We assume transfers and rollovers to eligible plans or IRAs are permitted. In the last three years before retirement.Įarly withdrawal penalty: We account for the fact that early withdrawals are subject to a 10% additional tax. Have been with their company for 15 years or more, and the special catch-up options available to those with 457(b) plans Special catch-ups: We also take into account the special catch-up options for employees with 403(b) plans who Use the current total catch-up contribution (not including employer matching) limit of $24,000 and assume it grows Maximum contribution: We use the current maximum contributions ($18,000 in 2015 and $53,000 including companyĬontribution) and assume these numbers will grow with inflation over time.Ĭatch-up contribution: We account for the fact that those age 50 or over can make catch-up contributions. Eligibility: Your employer needs to offer a 401(k) plan.
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