Employer-Sponsored Tax-Qualified Retirement Plans

While many companies offer employer-sponsored retirement plans, many employees are not taking advantage of this powerful retirement savings tool. A common reason is that you may not know what is available. Perhaps you may feel that planning for retirement is too complicated or time consuming. You are not alone.

As part of strategic financial planning, you should learn about the types of retirement plans your company offers. Contributing to an employer-sponsored retirement plan may help you reach your financial goals for your retirement.

Why should you know how much your company can contribute to your plan?

Your employer may also offer base or matching contributions to your retirement plan. This is free money. If you contribute enough to qualify for employer contributions, your retirement savings can grow even faster. This means that you will have more money available when you retire.

Knowing how much you can get from your company can help you maximize your tax-deferred retirement plan—you can build your retirement savings stronger with contributions from your employer.

How can you fund your employer-sponsored retirement plan with your current income?

You can fund your employer-sponsored retirement plan with your current income. How does this work? When you enroll in a tax-qualified plan, such as a 403(b) or 401(k), or a 457 Deferred Contribution Plan (DCP), you make pre-tax contributions to your account. While you may believe that you have too few dollars to save for retirement, you may find that you have "hidden" money available once you become a plan participant.

Since your contributions are made pre-tax, you are funding your account with money you already have. Basically, income that would have been taxed can be set aside for your retirement savings.

An employer-sponsored retirement plan helps you save money before you even see your paycheck. In turn, this may also help lower your taxable income per paycheck.

Are there any penalties or restrictions when withdrawing early from tax-qualified retirement plans?

Congress created tax-qualified retirement plans such as 403(b), 401(k) and 457 DCPs to help employees save for their retirement. This is why there are federal restrictions and a 10% federal tax penalty on early withdrawals from these retirement plans. (Generally, this is prior to age 59½ for most plans, 70½ for DCP plans. Ten percent penalty does not apply to a DCP).

Experts caution against using your retirement account to pay for a new car, home remodeling or vacation expenses. You may have to pay a 10% early withdrawal penalty. Also, withdrawing or borrowing money from your retirement plan reduces your savings amount—you have less money invested to grow. Over time, that can cost you a lot of money — money that you might need for your retirement savings.

Why should you remain invested?

Retirement planning experts recommend that plan participants remain invested for long-term. This is especially important if your plan is invested in securities. During short-term periods, the stock market fluctuates more frequently than in the long-term. The historical performance of the stock market suggests that you could benefit by staying invested — riding out the market's fluctuations. This is a valid strategy because the stock market historically has tended to rise over the long term. However, note that past performance does not guarantee future results.

As with any tax-qualified retirement investment, you pay income taxes upon withdrawal. Also, there are restrictions and potential penalties involved if you withdraw from your fund early.

How can you avoid the retirement income gap?

The Retirement Confidence survey also found that while just over 60% of American employees feel confident that they will have enough savings to live comfortably during retirement, only 46% of them have begun to plan for their retirement.

Retirement-investment experts say that most people depend on their retirement income from three sources: Social Security, the employer's pension plan and personal savings. Since Social Security benefits provide only about 40% of average retirement income, according to the 2001 Guide to Social Security and Medicare, other sources must provide the rest.

If it appears that the income you will need is greater than what you will likely have, you may have a "retirement income gap." You can avoid a retirement gap by developing a strategic retirement plan.

Your benefits administrator can connect you with a financial advisor whose expertise can help develop the appropriate retirement plan that suits your needs.

Knowing that you are preparing for your retirement by contributing to an employer-sponsored retirement savings can give you peace of mind—you know that you are building your nest egg.