By Dr. Gary L. Deel
Faculty Director, Wallace E. Boston School of Business
and Dr. Karin Ford-Torres
Faculty Member, Wallace E. Boston School of Business
This is the fourth retirement article in an ongoing series on sound tips for financial security and prosperity. These articles are intended to share a general overview of conventional, commonly practiced financial methods from business school faculty members and are in no way intended to influence or impart financial/legal advice or actions to or on behalf of readers. Readers should always consult with an attorney or licensed financial advisor before making any financial decisions.
In the previous article in the Smart Finance 101 series, we discussed the important differences between pre-tax and post-tax retirement investment strategies, and how we can make the best decisions with respect to these options. In this part, we’ll look at individual retirement accounts (IRAs) and Roth IRAs as they compare with 401(k)s and other types of employer-sponsored retirement accounts.
Types of Employer-Sponsored Retirement Plans
The first thing to note is that employer-sponsored retirement programs come in two primary types — mandatory and voluntary. Mandatory plans are those that require employees to contribute a set amount from their paychecks each month. For example, 401(a) plans, which are commonly used by non-profit organizations and government employers, often mandate contributions from employees at a set percentage. Employers offer matching with these plans if they want to, but such reciprocation is not required.
Voluntary retirement plans allow employees to participate if they want to, but there is no requirement to do so. 401(k)s and Savings Incentive Match Plan for Employees (SIMPLE) retirement plans are the most common examples of voluntary employer-sponsored retirement plans. And again, there may or may not be employer matching with these plans as well.
Annual contributions to employer-sponsored retirement plans are not unlimited. The current annual contribution limit is $19,500 for 401(k)s and $13,500 for SIMPLE plans. But if your employee’s total compensation is less than these numbers, you can contribute up to 100% of your pay to the plans.
The interesting thing to note is that if you are subject to a mandatory contribution retirement plan, those contributions do not count toward these annual limits. The limits stated above are for elective deferrals, so any amounts you are forced to defer are obviously separate. Dr. Deel notes, “In my case, I have experienced employers that have both mandatory and voluntary plans, so I only have to look at my voluntary plan contributions for the purposes of my annual limits.”
Another consideration with employer-sponsored plans is vesting for matching contributions. Under the law, employers may actually make their matches contingent upon certain conditions such as length of service.
For example, an employer may agree to match a certain percentage of your 401(k) contributions. But the employer may also require that you work for the company for a minimum of, say, five years before the company matching funds are officially “yours.”
If you stay five years, then you become fully “vested,” and the employer matches cannot be rescinded. But if you leave and/or are fired before you reach the length-of-service term, the company may pull back some or all of its own contributions.
Vesting contingencies are actually fairly common practice. It makes good business sense if you think about it. Employers want to make sure that, if they’re going to offer attractive benefits like matching, you (the employee) are going to stay with the company long enough to make the investment worthwhile.
As discussed in the last parts, there are traditional and Roth IRA options for retirement investment, but keep in mind that not all employers offer both, nor do they have to. The standard option is the pre-tax investment. But some employers also offer a Roth option in their retirement plans which allows you to diversify your investment strategies.
Saving for Retirement if Your Employer Doesn’t Offer Any Plan
But what if your employer doesn’t offer any kind of retirement plan? This is not uncommon, as a lot of smaller businesses may not have the capital to support such offerings. Not to worry, though. You can still invest in your retirement in the form of traditional and Roth individual retirement accounts (IRAs).
You can open an IRA at almost any bank, credit union or investment firm. Some have minimum initial deposit/investment requirements. And you can usually choose how you want your money invested, among individual stocks, bonds, and mutual funds, and even packaged retirement index funds that diversify your investments across thousands of different holdings. But as with employer-sponsored retirement programs, there are income and age limits to how much you can contribute and when.
You may be able to contribute to a traditional (pre-tax) IRA and deduct your contributions if and only if you (or your spouse if applicable) are not already covered by an employer-sponsored retirement plan. For the Roth (post-tax) IRA, you can contribute only if you do not exceed certain income caps — roughly $140,000 modified adjusted gross income (MAGI) for single persons and $208,000 MAGI for married couples.
Even then, there are caps on how much you can contribute to both of these types of plans, which depend on income, age and other factors. The details go beyond the scope of these articles, so you should visit the IRS website or consult with a licensed financial advisor for the specifics.
But one key topic we haven’t yet covered is: When can you access your money? In other words, when do the retirement accounts pay out? Can you withdraw money from them early? If you do, will you pay a penalty? We’ll address these final questions in the final part.
American Public University and American Military University offer academic programs in accounting and finance, which cover important financial discussions in depth. Readers who are considering expanding their knowledge and credentials in this field are encouraged to visit our program pages for more information.
About the Authors
Dr. Gary Deel is a Faculty Director with the Wallace E. Boston School of Business at American Public University. He holds a J.D. in Law and a Ph.D. in Hospitality/Business Management. Gary teaches human resources and employment law classes for American Public University, the University of Central Florida, Colorado State University and others.
Dr. Karin Ford-Torres is an Associate Professor with the Wallace E. Boston School of Business at American Public University. She holds a Ph.D. in Business Administration with a concentration in Advanced Accounting and Financial Management. Karin teaches accounting and finance courses for American Public University, Purdue University Global and Colorado State University-Global. She has 24 years of prior banking experience with Bank of America.