Employer-Sponsored Plans for Retirement

An employer-sponsored retirement plan is a workplace benefit offered by some companies to help provide workers with income in retirement. Employer-sponsored plans take different forms, but they fit primarily into two categories:

• Defined benefit plans, which promise workers a specific amount of retirement income.
• Defined contribution plans, which don’t guarantee any retirement income but instead allow workers to save for their own retirement, often with some employer assistance.

Employer-sponsored retirement plans are very common. In March 2020, the Bureau of Labor Statistics reported that 67% of nonunion workers and 94% of union workers had access to them. However, there are pros and cons workers should consider before using a workplace retirement plan to save for their later years.

Types of employer-sponsored retirement plans

Types of employer-sponsored retirement plans

Employers determine the type of retirement savings plan they want to offer. Workers often, but not always, can opt in or out. Some of the most common types of employer-sponsored retirement plans include the following.

Qualified retirement plans

Qualified retirement plans

Qualified retirement plans are tax-advantaged retirement plans subject to the 1974 Employee Retirement Income Security Act (ERISA) rules, as well as IRS guidelines. ERISA requirements are extensive. Plans are subject to minimum participation requirements, annual contribution limits, and vesting requirements.

Employers and employees can contribute to them with pre-tax dollars, but employers are subject to reporting, disclosure, and funding rules.

Non-qualified retirement plans

Non-qualified retirement plans

Non-qualified retirement plans are employer-sponsored retirement plans that do not have to meet ERISA guidelines. These plans are often provided to highly compensated employees as a benefit.

Non-qualified plans aren’t subject to annual contribution limits, and there are far fewer reporting requirements. Unlike qualified plans, they’re funded by employers with after-tax dollars. Employers can limit participation to select employees.

Defined benefit plan

Defined benefit plan

A defined benefit plan is an employer-sponsored retirement plan that guarantees an employee will receive a certain amount of money in retirement. Also called pension plans, defined benefit plans require employers to assume investment risks and responsibilities.

The amount of money an employee receives is determined by a formula usually based on years of service and salary. Benefits can take the form of fixed monthly annuity payments, or employees may receive a single lump sum payment. In many cases, if an employee dies, his or her surviving spouse is entitled to receive benefits from the plan.

Defined contribution plan

Defined contribution plan

Defined contribution plans are more common than defined benefit plans, especially among private-sector workers. Under most of these plans, including 401(k)s, 403(b)s, and SIMPLE IRAs, employees are provided with the opportunity to defer a portion of their salary with pre-tax dollars but aren’t required to do so.

Employers can make voluntary contributions for a 401(k) or a 403(b). In the case of a SIMPLE IRA, employers must make mandatory contributions based on a preset formula. A SEP IRA is another type of defined contribution plan, but only employers can contribute to it.

With defined contribution plans, employees shoulder the investment risk and are largely responsible for ensuring their own retirement security. Employees are not guaranteed any minimum retirement income, and account balances fluctuate depending on changes in the value of investments.

Vesting retirement plans

Vesting retirement plans

Some workplace retirement plans offer employees ownership only after they fulfill certain requirements, such as working for a certain number of years.

In defined contribution plans, worker contributions are always 100% vested, meaning the employee owns them right away. However, if employers make matching contributions, there may be a vesting schedule that either transfers ownership to the employee slowly over time (on a graded vesting schedule) or all at once after the employee fulfills a specific requirement (on a cliff vesting schedule).

Generally, employees must be fully vested and have 100% ownership of employer contributions after:

• Three years under a cliff vesting schedule.
• Six years under a graded schedule.

Vesting is also common in defined benefit plans where employers guarantee a certain amount of retirement income. Employers must allow workers to be 100% vested in employer-funded benefits within:

• Five years under a cliff vesting schedule.
• Seven years under a graded vesting schedule.

Pros and cons

Pros and cons of employer-sponsored retirement plans

For those who work for employers offering retirement plans, it’s important to weigh the pros and cons of participating in a workplace plan versus using other types of retirement accounts such as individual retirement accounts (IRAs).

Advantages of employer retirement plans

Here are some of the biggest benefits of participating in a workplace retirement plan.

• Some plans offer guaranteed income. Defined benefit plans remove the risk of retirement investing for employees.
• Employers often provide a company match on your contributions for plans that don’t have a defined benefit. This is free money workers shouldn’t pass up, even if it means they must put money into their workplace retirement plan to earn matching funds.
• Sign-up is generally simple. Some companies automatically enroll workers in retirement plans, while others require some simple paperwork. It can be easier to enroll in a workplace plan than it is to open your own retirement account and save independently.
• Contribution limits are often higher. Workplace 401(k) accounts and other similar defined contribution accounts have higher limits than many tax-advantaged accounts that workers can open themselves, such as IRAs or health-savings accounts (HSAs).
• Investing is often automatic. Workers can sign up to have contributions to their retirement account taken directly out of their paychecks, ensuring money is invested regularly. In some companies, contributions are automatically withdrawn unless workers opt out.

Disadvantages of employer retirement plans

Here are some downsides of employer retirement plans.

• You may need to work a certain amount of time to become eligible. This could trap you in your job or may mean you need to consider other investing options if you don’t plan to remain with your employer long enough to qualify.
• You have less flexibility in investments. If you have a 401(k) or similar defined contribution account, you may be limited to investing in a select few mutual funds offered in your workplace account. IRAs and brokerage accounts offer far more options. You can invest in whatever stocks, bonds, mutual funds, or exchange-traded funds (ETFs) you choose.
• Some plans come with high fees. You may have to pay a management fee for your employer plan.