The Types Of Employer Retirement Accounts
Now that you know about the basic types of investment products, you may be wondering, “Where do I put my money?” There are a lot of investment accounts, each suited for different purposes. The main category you need to focus on is retirement. The main reason is because retirement investment accounts are tax sheltered or tax deferred. This perk gives you the opportunity to grow your money without being penalized by taxes on a yearly basis which allows your money to compound and be reinvested at a greater rate.
A lot of people may want to invest for their children’s education before their retirement. Education, a wonderful aspiration for your children, needs to be a secondary priority for you. Why? While your child has the potential to obtain financial aid, scholarships, and loans to fund their education, there is no such thing as financial aid for retirement. Retirement will also cost more in your lifetime than education. Parents also fail to connect the idea that if you do not fund your own retirement, children often have to step in and subsidize parents during their golden years. Parents are creating a larger burden than intended when they sought to do the right thing by funding their child’s education. The money you set aside now for educational purposes means that you are losing out on precious years of growth for your retirement fund.
Employer Provided Retirement Accounts
401(k) - This is the most common type of account in America’s retirement system. These are employee sponsored and come in Traditional and Roth formats. Traditional 401(k) plans deduct your contributions on a pre-tax basis, reducing your taxable income. Traditional 401(k) plans are tax deferred (which means earnings and growth are not taxed while they remain in the account), but withdrawals at retirement are taxed. Roth 401(k) plans deduct contributions on an after-tax basis, which does not reduce taxable income. Roth 401(k) plans are tax sheltered, which means withdrawals at retirement are tax-free (except for matching contributions and their earnings). For 2012, you may contribute up to $17,000 to a 401(k) plan. Investments are chosen from a menu of mutual funds that the 401(k) provider selects.
Many employers provide a matching contribution to 401(k) plans. You will see the match quoted as a percentage or a stated dollar amount. You should always contribute enough to get the match. For example, an employer might provide a match of up to 3% of the money you set aside for a 401(k). In this case, you should contribute at least 3% of your salary towards the 401(k). Other employers might provide a match of $10 for your first ten dollars contributed and $0.50 for every dollar after that, up to $20 dollars. In this case, you should contribute at least $20 of your paycheck into your 401(k). Matching amounts vary by employer. If you do not contribute enough to get the maximum match you are entitled to, you are throwing away money.
TSP - The Thrift Savings Plan is the retirement plan for federal government employees and members of the military. It functions much like a 401(k). Members of the military can contribute an increased amount when they are eligible for tax-exempt pay. Federal civilian employees get an automatic 1% contribution even if they do not elect to put aside any money for the TSP. They also receive an Agency Matching Contribution up to 4% for employee contributions of 5% or greater. The maximum match is 5%. Generally, the military does not receive matching contributions. The Federal Retirement Thrift Investment Board contracts with professional investment managers to handle the trust fund assets. The trust funds act like mutual funds, but are not traded on the open market and are not available to the public.
457(b) – This is the retirement plan for state and local government employees or tax exempt organizations. They are often referred to as Deferred Compensation plans, and again, they function like 401(k)’s. Traditional or Roth contributions are available. Roth 457(b) plans are just starting to emerge and you may not see them at your particular employer. If you want to make Roth contributions, contact your Deferred Comp coordinator and let them know you are interested. Matching contributions to 457(b) plans are rare, if any at all. Investments are chosen from a menu of mutual funds, like the 401(k).
403(b) – This is a retirement plan offered by many public schools and some tax exempt organizations. These types of plans have come under scrutiny lately because of their lack of transparency. This is because most of these plans are administered by insurance companies. With 401(k) plans, and the like, one company is contracted to manage the program and provide investments for employees to choose from. In 403(b) plans, employees are sold plans by individual insurance agents who capture commissions on annuity contracts sold. This means that two teachers at the same school can have different retirement account providers and can be paying different amounts for potentially the same type of annuity. The cost disparity means public school employees get shortchanged when it comes to growth in their retirement funds.
Employees can also place money into a custodial account, which can invest in mutual funds. However, due to the conflict of interest, employees are most likely pushed towards annuity contracts since it will bring a higher commission and residual amount to the insurance agent. Most school systems who are using the 403(b) plan are starting to recognize this problem and are making efforts to reform the program so it becomes more transparent and cost efficient.Posted by Long