Millions of young Americans (from generations such as Generation X, Millennials, Generation Z and others) have been discovering how urgent the need is to start their retirement plan. And the thing is, experts recommend starting as soon as possible, because the younger you start, the more savings you’ll have when you reach your retirement age.
Lately, there has been a lot of talk about 401(k) retirement plans, which have many advantages, among which are that employers can contribute additional resources to those contributed by the worker. This is a valuable tool for building a comfortable, high-dollar nest egg for an all-paid retirement.
Retirement Plans With Employer Contributions: Grow Your Savings
The most common and popular type of employer-sponsored retirement account is the 401(k), which allows employees to make tax-deductible contributions from their paycheck. Those contributions are invested in a wide variety of investment options, such as stocks, bonds, or mutual funds, which are chosen by the retirement fund provider of your choice. The profits from investments grow tax-free until they are withdrawn in retirement.
How do employer contributions work in 401(k)s?
The employer contributions of this type of plan are money that your company contributes to the fund. This money can be saved for your future, which add up and grow with your own contributions.
The types of employer contributions can be two:
Required Contributions: These contributions are only awarded if you make an elective contribution to your 401(k) plan. The employer will match your contribution up to a certain percentage or up to a maximum limit.
Non-contributory Contributions:
These contributions are awarded to all eligible employees, regardless of whether or not they make elective contributions. The employer usually contributes a fixed percentage of the employee’s salary.
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Example of growth of a 401(k) plan
Let’s say you earn $70,000 a year, and you contribute 6% of your salary to your 401(k) plan, how much does this amount to per year in contributions?
Annual contributions:
- Your contributions: 6% of your annual salary = $70,000 * 6% = $4,200
- Employer’s contribution:
- The employer matches 50% of your contributions, up to a maximum of 3% of your salary: 50% of your contributions = $4,200 * 50% = $2,100
- Employer’s maximum limit = $70,000 * 3% = $2,100
- Since the employer’s maximum limit matches 50% of your contributions, the employer’s contribution will be $2,100.
- Total annual contribution: Your contributions + Employer contribution = $4,200 + $2,100 = $6,300
Total savings in 25 years:
To calculate the total savings over 25 years, we must consider the growth of investments. Let’s assume an average annual rate of return of 7%:
- Total savings: $6,300 per year * 25 years = $157,500
(Growth with compound interest)- Using the compound interest formula:
- A = P * (1 + r)^n
- Where:
- A = Final amount
- P = Initial amount ($157,500)
- r = Annual rate of return (7%)
- n = Number of periods (25 years)
- A = $157,500 * (1 + 0.07)^25 ≈ $643,800
Total: Your contributions + Growth with compound interest = $157,500 + $643,800 ≈ $799,300.
What’s a 403(b) Retirement Plan?
Actually, 403(b) plans are quite similar to 401(k)s, but they are designed specifically for non-profit organizations, educational institutions and certain government agencies. Like 401(k)s, 403(b)s contributions are tax-deductible, and investment gains grow tax-free until it’s time to retire.
An important benefit is that many retirement plans of this type are sponsored by the employer: it matches a part of the employee’s contributions, up to a certain allowed percentage, or up to a certain income limit. For example, if an employee contributes 6% of his salary to the plan, the employer could match 3%, which gives the employee a total of 9% in his retirement account.
Ten finds that these types of retirement plans are intended to be a very long-term savings, so withdrawals of money before the age of 59.5 are usually subject to penalties and income taxes.
Regarding the investment options, in 401(k) accounts they are offered by the employer and may be limited. in the case of IRAs, investors have a wide range of investment options to choose from, including stocks, bonds, mutual funds and ETFs.
