Alternate Employer-Sponsored Plans
Some employers offer different options to bolster your retirement funds. These plans also offer opportunities to substantially increase your retirement savings, so it pays to review the benefits available and to take full advantage of them. Self-employment options are discussed later in the chapter; keep in mind that some small employers may offer the types of plans outlined in that section.
Defined-Benefit Plans
A defined-benefit plan guarantees employees a certain payment schedule when they retire. In the old days, defined benefit plans were considered the Cadillac of retirement plans because the guaranteed payments were likely to be higher than any returns employees might have earned on stock, bond, or other investments. Plus, the employee didn't have to fund the plan, only reap the rewards.
If your employer has this type of plan, you may feel lucky — particularly if you will likely work for the same employer until you retire and if the company is rock solid.
Defined benefit payouts usually increase steadily based on the time you've served with the firm and your average, or highest, salary over your last few of years of employment. Most plans offer incentives for employees to work until age sixty-five, and those who don't have reduced payments for the life of the support.
Alert
Some companies make matching contributions by offering employees company stock, but you should always be wary about becoming overly invested in one stock, no matter how hot your company is at the moment. If something goes wrong and a lot of your wealth is tied up in company stock, you could lose most, if not all, of your retirement savings.
If you are eligible for a defined benefit plan, it's important to know its vesting schedule. Similar to some tax-advantaged accounts, defined benefit plans have either cliff vesting schedules, which allow you ownership of a certain level of benefits at one time, or graduated vesting, which awards you ownership of the plan's benefits gradually over time. If you change jobs or are fired before some or all of your benefits are fully vested, you will lose any claim to the nonvested benefits.
If your firm offers a defined benefit plan, seek out a human resources person at your firm and ask for clarification on what the specific benefits are and how quickly you become vested. Make sure you know the consequences of changing jobs or losing employment.
If you receive an attractive job offer at another firm, make sure you weigh the new retirement plan against the benefits of your current defined benefits plan. Sometimes the defined benefits plan offer “assets” that far outweigh an increased salary being offered elsewhere.
Profit-Sharing Plans
Profit-sharing plans are usually offered along with a 401(k) and allow contributions only from employers. Your employer may contribute between 0 and 25 percent of your income each year to the plan, to a maximum of $44,000 in 2006 (adjusted annually for inflation), with benefits beginning to accrue no later than two years into your employment.
Vesting restrictions apply, with the most common vesting schedule being 20 percent per year starting in the second year of employment. Investment earnings grow with taxes deferred until you withdraw funds. You'll be charged a 10 percent penalty for withdrawals from a profit-sharing plan before you reach age 59.5.
There are two main differences between this type of plan and a 401(k). The maximum you're allowed to put into profit-sharing, tax-advantaged retirement accounts in total is higher, and profit-sharing plans can have longer vesting periods, up to seven years. They both grow tax-free and are taxed as ordinary income when you withdraw funds from the plan.
Employee Stock Ownership Plans (ESOPs)
With an Employee Stock Ownership Plan, your employer puts shares of company stock into the account. You can become rich through an ESOP if your company's stock does well over time, but you'll also usually end up with an extra-large position in your own company's stock. You have no control over the shares in an ESOP until you've been with the company for a while, usually 10 years, and are over age 55.
Essential
Contributions aren't included in the employee's income in the year they are made, and value grows tax-free until the employee takes distributions from the plan. At that point distributions are taxed, but the rate varies. Vesting can be “cliff” or “graduated,” with a three-year cliff option or six-year graduated option (starting in year two, with five years of 20 percent vesting).
If you've been part of the plan for at least 10 years, at 55, you have the option to sell 25 percent of your holdings, and at 60, you can sell a total of 50 percent for diversification purposes. Contributions aren't counted as income in the year made, and plan assets grow tax-free until you withdraw funds. Tax treatment of withdrawals is complex, so seek help from a tax professional.
Vesting options of ESOPs can be cliff vesting after three years, or graduated vesting for a maximum of six years, starting in year two. Dividends paid on company stock in your account may be paid out to you, in which case they are treated as part of your income.
The downside of ESOP plans is that your path to riches — an oversized position in your own company's stock — can lead to a large retirement shortfall if the value of your company's stock doesn't increase at a reasonable rate over a long period of time. Be ready to diversify into stocks and bonds not related to your company's performance when you reach 55 and 60. Remaining invested largely in any one company's stock is very risky.
