HUMAN RESOURCES Transition to Business By Paul Falcone
Family & Transition: Your Private Sector Retirement Options This month’s editorial calendar focuses on, among other things, transition and education, especially for spouse and family. Few topics are better suited to capture all these audiences than your private sector retirement plan. True, you may have a handsome pension plan from your military years of service, but there are additional tax and longterm benefits to investing in your retirement through your private sector employer. Here’s a quick overview of some of the choices that lie ahead in addition to this author’s recommendation for the long haul.
Defined Benefit (aka “Traditional”) Pension Plans Traditional pension plans are fairly rare in corporate America these days, but if you’re fortunate enough to be offered a position with a company that has a defined benefit pension plan in place, run—don’t walk—to accept their offer! That’s because this typical benefit trumps all others and is incredibly valuable in terms of its longterm potential. A “defined benefit” pension, or “DB” plan, provides a monthly annuity or lump sum that you receive at retirement by using a set formula that includes your compensation and your years of service with the organization. Typically, you become eligible to participate in the plan once you reach some service milestone (typically around five years), and it “guarantees” a monthly payout once you reach age 65. (There can be exceptions in terms of corporate bankruptcies, but the Pension Benefit Guarantee Corporation in Washington, D.C. can “guarantee” a percentage of the total payout). 32
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The key to traditional pension plans, unlike 401(k) plans, is that the company typically pays the entire cost of the benefit and assumes all risks related to the investments, and there is no cost to the employee. Defined Contribution (aka 401(k)) Plans 401(k) plans and their brethren—403(b) plans in the nonprofit sector and 457 plans in the public sector—like traditional pension plans, help you save for retirement. There’s one major difference, though—you’re saving your own money that you deduct from each paycheck and are fully responsible for the outcomes of your investment choices. Not quite as attractive as the traditional pension plans described above, 401(k)s make up the bulk of retirement options at most companies and have some unique tax advantages as well. The model works well in terms of its efficiency and incentives. Companies receive tax breaks if they match a certain percentage of employee investments, and workers receive tax breaks if they set aside a particular amount of money for their own retirement. Do your best to start investing in the company’s 401(k) as soon as you are eligible. Pay particular attention to the company “matching” aspects of the plan. Take advantage of the “full match” offered by the employer. For example, if the company matches $.50 on the dollar up the first six percent of your earnings, set aside six percent of your earnings in your 401(k) plan. You can always go higher and invest more, but don’t leave free money on the table: invest up to the company’s match whenever possible. Traditional versus ROTH 401(k)s 401(k) plans, like Individual Retirement Accounts (IRA), come in two basic flavors: Traditional and ROTH. The difference between the two has to do with tax treatments of the deductions now and the payouts later in your retirement years. “Traditional” 401(k) plans are known as “salary reduction plans.” The “salary reduction” element stems from the fact that the money invested by a worker is immediately hidden from taxation. In other words, if you earn $100,000/ year but contribute $15,000 to your Traditional 401(k) plan, the government will tax you as if you only earned $85,000 that year.