Although retirement plans have maximum contribution limits per law, most people find that their own contributions are constrained mainly by their budget. Allocating funds for the future means less available to spend now. Obviously, you should contribute as much as possible to your retirement plan as this is an easy way to automatically accumulate and invest money without putting too much thought into the process. The psychological advantage to this is that you are less likely to save and invest money once it goes into your checking. Fortunately, employers can help with this process by allowing it to be done automatically through their company’s retirement plan. The other advantage to contributing to your company’s retirement plan is that your investments grow tax deferred which can enhance your total return over a long time period.
About Company Retirement Plans
Retirement plans into which employees contribute are also known as defined contribution plans, an example of which is a 401(k) plan. Most retirement plans have a matching provision or safe harbor provision in which employers also contribute so the plan remains qualified by ERISA (Employee Retirement Income Security Act). Contributions to these plans may be pre-tax or after-tax from your earnings.
The pre-tax contributions are known as you elective deferral contributions, and in 2014 you can contribute up to $17,500 under the age of 50. Over the age of 50 you may have an additional elective deferral of $5,500.
After-tax contributions to a retirement plan are limited to $34,500 if your gross wages are over $52,000. Combined, the dollar limitation to retirement plans in 2014 is the lesser of gross compensation or $52,000, and if you are over the age of 50 it is $57,500.
Recommended Contributions to Your Retirement Plan
Every investor has different circumstances and cash needs, but we recommend that if you do have a retirement plan offered through your employer, that you do try to contribute as much of the elective deferral (pre-tax) as possible. As the name implies, pre-tax contributions are not subject to income taxes, thus can significantly reduce your tax liability. The younger you are when you begin contributing to these plans the better you will be as you near retirement. Most retirement plans require that its participants be at least 21 years old and have been employed for at least one year. This is not to be confused with pension plans, where employees begin accruing service time from their first year of employment regardless of age.
A Note about Vesting
Typically, most individuals will work for several employers over their career, and it is worth noting how each company vests their contributions to your account. Defined contribution plans will fully vest over the following schedule:
- 3-year cliff (fully vested after three years),
- 2- to 6-year graded
- 100% vested with two year eligibility requirement.
That said, contributions or matches made by your employer to your account will most likely be fully vested after six years of employment at the same company. When you are fully vested, you have the ability to leave your firm and rollover the account to an existing IRA or you may be able to roll into your current employer’s plan. We recommend that when you do separate from service that you transfer your account to an IRA or another plan so that the funds remain tax-deferred.
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