Whether you are just starting out your career or you’ve been working for decades, retirement savings should be top of mind. A recent study of retirement savings in America indicates that 2/3rds of those in their 40s have less than $100,000 in retirement savings. On top of that, nearly half of individuals in their 40s have withdrawn from their retirement funds. If you are fortunate enough to work for a large company such that they offer a retirement plan, you have a great opportunity to get your retirement savings started on the right foot.
Unfortunately, those who either don’t have access to or aren’t familiar with a company retirement plan tend to forget how important retirement savings are. For this article, we will dive into the difference between company retirement plans and IRAs (Individual Retirement Accounts) so you can understand how to take advantage of the best available savings vehicles.
What are the differences?
Let’s start with the more simple savings vehicle which is the company retirement plan. While the 401k is the most common there are a few others that you may have come across in your career which are the 403b and 457 plans. All of these plans must be sponsored by a company or institution. 401k is the version for a for-profit business or corporation while the 403b and 457 plans tend to be for government or non-profits.
401k plans are by far the most commonly used/referred to retirement plan. These are active in the for-profit corporate world and once a company reaches a certain size and/or brings in enough revenue, they will typically offer a 401k. These plans, however, are not cheap from an admin perspective which is why it’s not required or standard for every company to offer one. Additionally, with a 401k the company can offer a match. A match is a promised contribution the company will provide to your 401k if you participate and/or contribute a certain amount. These are created to incentivize employees to participate in the plan and boost retirement savings. In many cases, a “good” match can be a great employee retention tool. Like employee stock options there might be a vesting period for these matches so be sure to see if that applies to you. Here’s an example:
The contribution limit for a 401k is $19,500 (as of 2020) with an additional $6,500 allowed if you are over the age of 50. Most 401k plans come with access to both a Traditional and Roth option so you can contribute to each type of savings vehicle. (To learn more about the difference between a traditional and Roth contribution read this article.) Note, the combined total is $19,500, not $19,500 each. The total contributions (employer via a match and employee) for 2020 can’t exceed $57,000 which is quite a bit into savings for one year if you are fortunate enough to have a match!
The money contributed to these accounts will grow tax free and is going to be taxed either on the way in (contribution, Roth account) or on the way out (withdrawal, Traditional account). If you withdraw funds before you are 59.5 you will receive a penalty of 10% in addition to any income tax if you are withdrawing from the traditional account.
Creating rules that lock up this money is part of the government's way to incentivize you to actually use this for retirement and not try to withdraw funds for other things. That said, if you do fall onto hard times you can always access this money and just pay the penalty. If certain circumstances are met, you may even be able to withdraw early without penalty. Chat with your Origin planner if you want to learn more!
457 plans are for employees that work for the state or local government. Each year you can contribute up to $19,500 (as of 2020) and an additional $6,500 if you are over 50 just like 401ks. A unique feature for these plans is that unlike other retirement plans you can actually withdraw funds before 59.5 years old. When you leave your employment with that particular state or local government you are able to withdraw funds penalty-free. Now, there will still be taxes owed if the funds were put in pre-tax but no additional 10% penalty that typically applies to early withdrawal. Additionally, these plans have some great perks as you get closer to retirement in the form of allowing up to double the contribution limit when you're 3 years from “normal” retirement age.
These plans are built for the non-profit or government sector including schools and teachers. These plans, like 401ks, have an annual contribution of $19,500 with a $6,500 catch-up for those over 50 (as of 2020). In addition, they have a maximum of $57,000 per year with the employer match. These plans typically can roll into a new employer 401k and definitively to an IRA. This allows you to take the plan and consolidate with other retirement assets if you leave your job.
Pensions are somewhat of a dying breed as they have become quite expensive to maintain. A Pension, unlike any of the plans listed above, is a promise from a government or institution to pay you X dollars when you retire or indicate you are retired. This falls on the institution to properly manage the funds to ensure they can pay you out when you retire. These plans can offer a lump sum payout or monthly income for the remainder of your life. The retirement plans we just covered leave the growth and investments in your hands so you can control your own investment fate. For some, however, having a company provide this for you can ensure you have income (this is a similar process with Social Security).
The beauty of these types of retirement plans is the high amount you are allowed to save each year. IRAs and Roth IRAs, are much more limited when it comes to access and eligible savings. The three big pit falls for these accounts are:
- The contribution limits are just $6,000 (in 2020) across both accounts with a $1,000 catch up over 50.
- You are not allowed to deduct contributions to an IRA (i.e. you lose the initial tax benefit) if you or your spouse has access to a retirement plan through work
- Roth IRAs can’t be contributed to at all if your income is above a certain threshold. See those thresholds here.
These limitations make retirement plans so much more attractive. You can not only contribute a significant amount more per year but you can also receive a match and contribute to a Roth account regardless of your income. We will always recommend trying to “max out” (contribute the maximum) to your retirement plans and then exploring other retirement vehicles.
What about the investments options?
While this article is filled with reasons to be excited about company or institution sponsored retirement plans there is one potential pitfall. With these plans your investment options are limited.
In retirement plans (outside of the pension) your plan has a limited number of investment funds specific to that plan. Occasionally, you can find a plan that allows you to “self manage” and invest in a wider range of investments, however, most employees will see that they can choose from roughly 30 funds. In today’s day, however, investment funds have really grown and become quite inexpensive and can still provide very reasonable returns.
If there is an investment management option, this might be great for those who don’t want to review and rebalance their account frequently. However, be on the lookout for higher fees associated with that management. Other plans have a “free” option to select the funds you’d like and the plan with auto rebalance on a regular basis for you. We always recommend doing this if available.
When it comes to picking your investment options, work with your Origin planner to see what is best for you, however, when in doubt, take a look at the target retirement date funds. Most plans offer a suite of funds that have a year attached to them like “2050” or “2060”. You would pick a fund that has a year which matches your expected retirement. For example, if you are 30 and plan to retire when you are 65 you would pick the 2055 fund (as of 2020). These funds will automatically make the investments more conservative as we approach that year (and your potential retirement). As long as the fund fees aren’t too steep (ideally we keep those under .50%) these are great options.
We know retirement savings can seem like such a marathon in a world where we have many sprints to reach goals like buying a house but it’s important to not leave retirement savings until it’s too late. We don’t want someone to end up in a situation where they can’t retire.
As always, if you need any help with this please reach out to your Origin planner.
TD Ameritrade 2020, Road to Retirement Survey. Viewed August 08, 2020. https://s2.q4cdn.com/437609071/files/doc_news/research/2020/road-to-retirement-survey.pdf