Personal Finance Essentials

Workplace Retirement Plans

Most Americans Are Leaving Free Money on the Table and

Saving Less Than They Think

Retirement Savings

The 401(k) Plan

The 401(k) is the most common retirement savings vehicle in America. Both employer and employee contributions are tax-deductible in the year they are made, and the employee pays income taxes only when money is withdrawn. Your money grows tax-deferred – meaning the government gives you a meaningful head start on wealth accumulation.

Most 401(k) plans offer a range of investment options from low risk (money market funds) to higher risk (stock funds), with many choices in between. The right mix for you depends on your time horizon and tolerance for risk. The answer is almost never cash alone, bonds alone or whatever performed best last year.

The 403(b) and 457 Plans

Workers in public schools, nonprofits and certain tax-exempt organizations contribute to 403(b) plans instead of 401(k)s. These plans operate similarly in terms of contribution limits and tax treatment.

The 457 plan is offered mostly to state and local government workers, including police officers, firefighters and other civil servants. Employees of some state universities and school districts can contribute to a 457 plan in addition to a 401(k) or 403(b). Notably, the 457 plan has higher contribution limits for those within three years of normal retirement age – qualifying workers may contribute twice as much as younger workers.

The Employer Match: Free Money

Many employers match employee contributions up to a certain percentage of salary. This matching money is free – and it is among the most valuable benefits available to any worker. If your employer offers a match, contributing enough to capture the full match should be your first priority.

One key detail: contribute consistently throughout the year rather than front-loading contributions in early months. Some employers match only in months you contribute. A lump-sum contribution in January may cost you months of matching money.

Automatic Enrollment and Its Hidden Trap

Since 2006, employers have been permitted to automatically enroll employees in their retirement plans. As a result, plans with automatic enrollment see participation rates of 94% – compared to just 64% in plans with voluntary enrollment.  When auto-enrolled, the typical contribution is just 3% of pay, and the money is most often placed in a target-date fund.

According to The Wall Street Journal, 40% of auto-enrolled workers say they would have saved more had they not been set at 3%. Millions of workers are contributing less than they should because they accepted the default. Do not let auto-enrollment inadvertently reduce the amount you are saving for retirement.

The Danger of Company Stock

When Enron collapsed, its 21,000 employees lost both their jobs and their retirement savings simultaneously because they had placed all their 401(k) money in company stock. Even today, more than 70% of assets in some large companies’ retirement plans are invested in company stock.

This concentrates risk in the worst possible way: your income and your retirement savings both depend on the same company. If the company fails, you lose both at once. Diversification matters more here than anywhere else. Do not include your company’s stock in your retirement plan.