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How to contribute to a 401K, IRA, 403b and other retirement plans

At a glance:

At first glance, a list of common employer retirement plans may read like an alphabet soup — ESOP, 401k, 403b, etc. But understanding the basics of these plans is not difficult and can help you plan wisely for your future.

Knowing how you and your employer may contribute to these retirement plans can help you evaluate a job offer and take full advantage of your retirement plan options.

In short, understanding how — and how much — both you and your employer can contribute to these plans can help you achieve your long-term financial goals.

What are employer retirement plans?

Employer retirement plans are exactly what their name suggests: offered by your employer, these investment plans help you accumulate money that can provide you an income in retirement.

Most retirement plans are authorized under sections of the Internal Revenue Code — for example, section 401k or 403b — and all enable you, your employer, or both, to contribute to various investments for your retirement. You do not pay taxes on the earnings until you withdraw funds from the account.

An employer retirement plan permits you and/or your employer to annually contribute larger amounts toward your retirement than are possible with an individual retirement account (IRA).

The plan is tied to your employment, so employer contributions cease when you leave the organization, although you usually can roll the investment over into an IRA or other retirement plan.

One advantage of some employer retirement plans is that you can contribute pre-tax dollars to these investments. This enables you to lower your current income for tax purposes and defer taxes until you withdraw funds when you retire and when you may be in a lower tax bracket.

There are no finer tax shelters available to employees.

Types of employer retirement plans

Compared to your parents' or grandparents' era, today's Internal Revenue Service rules permit a full palette of retirement plan options provided by your employer. There is a hue and color to suit most employers — and employees.

Here we discuss several of the most common of these plans.

401ks

You have probably heard or read about 401k plans, or perhaps you are one of the more than 55 million Americans who participate in one.

401k and other plans enable employers to assist their employees' retirement planning efforts through contributions to each participating employee's account.

In addition, all employees — regardless of the amount of their salary or wages — can contribute to the plans through regular payroll deductions. Employees generally can choose to invest their 401k retirement funds in a number of alternatives—such as stocks and bonds, mutual funds, money market funds, and annuities.

SIMPLEs and SEPs: for smaller companies

While larger companies often provide 401k plans, smaller companies sometimes provide one of two types of individual retirement accounts (IRAs). Both are less costly to administer than 401ks.

The savings incentive match plan for employees (SIMPLE IRA) serves companies with 100 or fewer employees, including self-employed people. It may be structured like a 401k plan or a traditional IRA, except that the lower annual contribution limit does not apply.

The simplified employee pension (SEP IRA) enables a company to establish an IRA for each employee. For SEP IRAs established after 1996, however, only the employer may contribute — no employee contributions are allowed. For SEP IRAs established before 1997, employee contributions are allowed, but only if the employer had 25 or fewer employees eligible to establish a SEP IRA during the previous year.

Again, the lower contribution limit requirement does not apply. If you are self-employed, you also may establish a SEP for yourself.

Keoghs: for the self-employed

A Keogh plan provides another option if you are self-employed or an employee of an unincorporated business. It may take the form of a 401k or almost any other type of retirement plan qualified in the Internal Revenue Code.

403b: for non-profits

Finally, 403b plans offer a retirement savings option to many public school teachers, professors, and employees of non-profit organizations. These plans enable you to contribute pre-tax compensation to a mutual fund account or an annuity contract purchased from an insurance company.

They share certain similarities

Over the course of your working life, you may participate in a variety of employer retirement plans. While each plan has somewhat different rules — in the amounts and types of contributions permitted — all share several positive attributes.

All offer higher tax-deductible contributions than individual retirement accounts (IRAs), and all enable an employer to contribute toward the retirement needs of employees, making retirement planning easier for many people. Understanding how each plan can contribute to your retirement goals helps you ensure the future of your dreams.

Limits on employee contributions

Employer retirement plans enable you to invest a large portion of your compensation each year into a tax-deferred account, where your money can continue to grow in the tax-sheltered account. Your employer sometimes can also contribute to this account.

The Internal Revenue Code specifies different maximum annual contributions for both employees and employers. Here are the maximum allowable contributions for employees:

Limits on employer contributions

Your retirement investments can add up to a sizable nest egg after 20 or more years, particularly if your employer also contributes to your savings.

Here are the allowable employer contributions for several common retirement plans.

401k plans

For a 401k plan, employer contributions are limited, as a practical matter, by the limit on the employer's tax deduction for those contributions, as a wage and compensation expense.

The employer's deduction for additions to the plan is limited to 25% of its total payroll for all employees covered by the plan.

"Additions" include both employee elective salary reductions and employer matching contributions and can total up to the lesser of $57,000 per year in 2020 or 100% of compensation. Employer contributions, however, are not required.

Senate Minority Leader Sen. Chuck Schumer of N.Y., attends a news conference on 401(k) retirement savings, Tuesday, Oct. 31, 2017, on Capitol Hill in Washington. (AP Photo/Jacquelyn Martin)
Senate Minority Leader Sen. Chuck Schumer of N.Y., attends a news conference on 401(k) retirement savings, Tuesday, Oct. 31, 2017, on Capitol Hill in Washington. (AP Photo/Jacquelyn Martin)

SIMPLE IRAs

If your employer offers a SIMPLE IRA, he or she generally must match your contribution up to 3% of compensation.

To provide occasional flexibility, however, the employer can elect a matching contribution that is less than 3% — but at least 1% — for up to two years during the five-year period ending with (and including) the year for which the election is effective.

Because the employee's contribution to a SIMPLE is limited to $13,500 in 2020, the maximum employer match is likewise limited.

Alternatively, your employer may make a fixed contribution of 2% of compensation. If your employer elects the fixed contribution, he or she must make the 2% contribution for all employees with at least $5,000 in compensation, whether they contribute or not.

SEP IRAs

If you participate in a SEP IRA, your employer may contribute a maximum of 25% of your compensation.

If you also contribute to the account, you and your employer's combined contributions may not exceed $57,000 in 2020. (Note, however, that employee contributions are not allowed at all for SEPs created after 1996.)

Also, be aware that the Internal Revenue Code does not require your employer to contribute to a SEP IRA every year.

Keogh plans

If you have a Keogh plan that is a defined contribution plan (for example, a money purchase plan or a profit-sharing plan), your employer may contribute up to the smaller of $57,000 in 2020 or 100% of your compensation.

If you participate in a Keogh plan that is a defined benefit plan, your employer may contribute no more than the amount needed to fund an annual retirement benefit that is no larger than the smaller of $230,000 in 2020 or 100% of your average taxable compensation for your highest three consecutive years.

Millennials aren't contributing as much to their retirement. (Graphic: David Foster/Cashay)
Millennials aren't contributing as much to their retirement. (Graphic: David Foster/Cashay)

403b plans

If you participate in a 403b plan, combined employee and employer contributions may not exceed the lesser of $57,000 in 2020 or 100% of your annual compensation. 403b plans are offered by non-profit organizations, such as schools, hospitals, and churches.

Your employer's contributions can help you build a retirement nest egg faster than you could with only your own contributions. Taken together, employer and employee contributions can provide a sizable accumulation and a sizable portion of your retirement income.

Summary of employer retirement plans

Over the course of your working life, you may participate in a variety of employer retirement plans. While each plan has somewhat different rules — in the amounts and types of contributions permitted — all share several positive attributes.

All offer higher tax-deductible contributions than individual retirement accounts (IRAs), and all enable an employer to contribute toward the retirement needs of employees, making retirement planning easier for many people.

Understanding how each plan can contribute to your retirement goals helps you ensure the future of your dreams.

This content was created in partnership with the Financial Fitness Group, a leading e-learning provider of FINRA compliant financial wellness solutions that help improve financial literacy.

Read more information and tips in our Retirement planning section

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