How to Contribute More to Your Employer’s Retirement Plan in 2021
Contributing money to your employer’s retirement plan is a strategic long-term plan to support yourself in your golden years.
What should you do if you want to up the ante a little more this year? Great question — we’ve got you covered.
Why Contribute More to My Employer’s Retirement Plan?
You want to contribute to your employer’s retirement plan, and here’s why.
Reason 1: Many employers kick in free money.
Many employers include matching-contribution provisions, and you could be losing the benefits offered by your employer if you don’t contribute a portion of your salary through salary deferral. In other words, you miss out on free money if you don’t take your employer’s offer to match contributions!
You want to try your best to contribute up to the maximum amount your employer will match to get the most benefit from your contributions.
Reason 2: Your money can grow tax deferred.
The words “tax deferred” sound really complicated and scary. However, you want your money to grow tax deferred. It simply means that if you save your money in a tax-deferred retirement account like a traditional IRA or 401(k), you don’t pay taxes up front.
This means you can skip paying taxes like you do in your paychecks. Instead, you can let your money grow and you don’t pay taxes on the amount you earn until you take withdrawals in retirement.
If you choose a Roth option (more on this later), you pay taxes up front and don’t have to pay taxes at all when you withdraw your money in retirement.
Reason 3: Money compounds over time.
Money grows like crazy over time thanks to something called compound interest. Compound interest simply means allowing investment earnings to earn interest, and this takes time.
The amount you’ll have to save to fund your retirement is dramatically lower the earlier you start. In fact, try saving just $300 per pay period when you start out. If you do that for 10 years, you might not ever have to save another dime for the rest of your life.
If you’re getting started later, that’s okay. Contribute as much as your plan will allow.
What are Retirement Plan Options?
You usually get what you get when you join a company. In other words, the retirement plan your company has is the one you need to get on board with. Check out a few common retirement plan options — you may have access to one of these.
Payroll Deduction IRA
Let’s say your employer doesn’t want to adopt a retirement plan. A payroll deduction IRA can help you contribute to an IRA through simple payroll deductions.
Salary Reduction Simplified Employee Pension (SARSEP)
A SARSEP is a simplified employee pension that includes a salary reduction arrangement. It’s usually cheaper to administer this type of plan compared to larger, complex plans. Here’s how it works: Your employer makes contributions to its own IRA and the IRAs of its employees within certain pay percentages and dollar limits.
Simplified Employee Pension (SEP)
Your employer can make contributions to your retirement savings with a simplified employee pension (SEP) so they don’t need to set up a profit-sharing or money purchase plan with a trust. Your employer can make direct contributions to your individual retirement account or an individual retirement annuity.
SIMPLE IRA Plan
Do you work for a small company? A SIMPLE IRA plan lets your employer set up a tax-favored retirement plan. You sign a written salary reduction agreement that allows you to contribute salary reductions to a SIMPLE IRA.
A 401(k) plan one type of defined contribution plan that allows you to defer salary and/or employer contributions.
SIMPLE 401(k) Plan
If you work for a small business, a SIMPLE 401(k) plan is one way to defer salary to a plan if you work for a company with 100 or fewer employees. Your employer must make a matching contribution up to three percent of your pay or opt for a non-elective contribution of two percent of your pay.
403(b) Tax-Sheltered Annuity Plan
If you work for a public school, college, university, church, public hospital or a charitable entity deemed tax-exempt under IRC section 501(c)(3), you may be able to contribute to a 403(b).
A profit-sharing plan is a type of defined contribution plan which allows your employer to make discretionary employer contributions.
Money Purchase Plan
Your employer makes fixed employer contributions with a money purchase plan.
Defined Benefit Plan
Your employer funds a defined benefit plan, and contributions are actuarially determined for this type of plan.
How to Contribute More to Your Employer’s Retirement Plan in 2021
Think you need to up your retirement game? Good for you. Here’s how to make it happen in the new year. (We’ll use a 401(k) as an example, but you may have another type of plan at your disposal through your employer, as seen above. In that case, the steps might vary a bit.)
Step 1: Ramp up your contribution percentage at the end of each year.
Put it on your calendar now: At the end of each year, vow to ramp up your retirement contribution by at least one percent. The younger you are when you start saving, the longer the money has to compound. Make savings automatic and use the percentage amount savings option — never opt for the dollar amount option. Try to ramp up your contributions whenever you get a raise. A good rule of thumb is to save 10 percent of your gross wages as soon as possible. If you can’t afford 10 percent, start at five percent, then add a percent or two every year.
If you want to really ramp things up, increase your percentage every month or start at 10 percent right now.
Step 2: Get your employer’s match.
An employer match is free money and one of the best incentives to save for retirement. Let’s say you earn $50,000 per year. You can boost your retirement savings by $1,500 each year if you take advantage of a company match of 50 percent of your contributions up to six percent of pay. What should you do if your employer doesn’t offer a match? You can still defer income taxes on the amount you contribute until retirement.
Step 3: Go after a Roth 401(k) if you think it’ll benefit you.
You might have heard about this type of retirement fund, and Roth 401(k)s might be a great strategy if you’re currently in a low tax bracket. If you think you’ll retire in a higher tax bracket than you are right now, it’s a really good idea to consider a Roth 401(k). You make Roth 401(k) contributions with after-tax dollars and withdrawals in retirement are tax-free.
Step 4: Diversify your investments.
No matter what type of plan your employer offers, you can usually choose from a small investment option selection. Choose the mix of stock funds, bonds and cash that fits your personal risk tolerance. Depending on your age, you may want to shift to less risky investments as you get closer to retirement age.
Step 5: Monitor your investments and talk with a company advisor regularly.
It’s easy to invest in your retirement account one time, but then never check your account ever again. Avoid doing that. You want to know what’s going on in that account at all times. And if the numbers don’t make sense to you, meet with your company’s financial representatives. Most companies have these individuals come in regularly for you to talk about your savings and all your options.
And if you decide to switch jobs, don’t cash out your retirement account. You’ll get hit with a massive early withdrawal penalty — 401(k) withdrawals get hit with a 10 percent early withdrawal penalty and regular income tax on the amount withdrawn. Instead, you can leave the money there, move it to your new employer’s 401(k) or transfer the money into an IRA. This way, you avoid penalties and continue to grow your money, tax-deferred (there’s that term again!).
Step 6: Be aware of your company’s vesting schedule.
What’s your employer’s vesting schedule? No idea what that means? No worries. It simply means that some employers require workers to remain with the company for a certain number of years before you can keep the 401(k) match. Learn more about how your company’s vesting schedule works and seriously consider staying at the company until you can have your employer’s retirement contributions when you leave. You don’t want to flush that (free) hard-earned money down the drain.
How Much Should You Contribute?
This deserves some attention because it’s tough to know how much to contribute. Check out a few hints:
- Use a retirement calculator like Vanguard’s to find out whether you’re currently on the right track with your retirement savings.
- As a rule of thumb, experts advise that you save between 10 and 20 percent of your gross salary toward retirement.
- The actual amount you should save depends on your individual situation. For example, let’s say you’re 48 years old and you haven’t saved anything for retirement. In that case, you should save more than 20% of your gross annual salary.
- At the very least, get your employer match.
- Contribute as much money as you can toward retirement.
Contribute More in 2021
Congratulations on your willingness to explore how to boost your retirement savings. It’s a huge step in the right direction.
Once you’re set on your retirement contributions, figure out how you’ll contribute to other things, like paying off your mortgage, saving for college with UNest (learn more about 529 plans — get ready for those tuition payment plans!) and building up your emergency fund.