How do employer-sponsored accounts work?

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Do you like free money?  If the answer is “yes,” you will want to be aware of how employer-sponsored accounts work.   Some employers offer defined benefit plans in which they put money aside, and promise you a pre-determined monthly payment when you retire.   These plans are commonly referred to as pension plans.  Pension plans are less popular today than they were thirty years ago.  Today, the most common type of employer-sponsored plan is the defined contribution plan.   Both 401(k) and 403(b) plans fall into this category.

With the 401(k) plan, employers typically match at least part of your contributions.  The terms of employer contributions vary widely from company to company, so you should figure out the details as soon as you begin work—or, ideally, in comparing your job offers.

But the money isn’t completely free, of course; you have to invest in your 401(k) in order to receive your employer’s contribution.  Thus, as with every retirement account, the amount available to you at retirement will depend largely on how much you manage to set aside in the course of your career.  You can use the funds in your 401(k) to invest in market funds (e.g., a Dow Jones index fund or a mutual fund), bonds, and sometimes individual stocks, depending on your employer’s stipulations.  If you change employers, you will be able to roll over your 401(k) to the new employer.

Employer 401(k) plans vary in terms of matching policies and vesting requirements.  Your employer may match a percent of your contribution or match it dollar for dollar—or anything in between.  To prevent new hires from making out like bandits with their signing bonuses and 401(k) matching contributions, employers usually require a certain length of time to pass before the employee’s ownership of any given employer contribution “vests.”  For example, if the vesting period is 2 years, then when an employee resigns, in order to keep all employer contributions he or she must have worked for at least 2 years.  Depending on the plan, vesting periods can vary from one month to seven years.

The federal government limits employees’ 401(k) contributions to $17,000 per year ($22,500 if you are over the age of 50) because they also have an important tax advantage: your contributions are deducted from your taxable income.  You pay no income tax on contributed amounts until withdrawn years later.  Withdrawals, both your principal and gains, are generally taxed as ordinary income.  An additional potential tax advantage is that you may be in a lower tax bracket during retirement than when you made the contribution.  Withdrawals are optional without penalty at 59 ½ and become mandatory at 70½.  A minimum distribution must be taken by April 1 of the year following the year you reach 70 ½.

If you are a public school employee or work for a tax-exempt organization, you may be eligible for a 403(b) retirement savings plan.  Find more information here.

If you are a government employee, you may be eligible for a 457 retirement savings plan.  Find more information here.
 
Duke graduate students, who receive their earnings from scholarships and fellowships, are not eligible for Duke’s 403(b) plan. 

For additional information, see Guide to your 401(k).