The majority of American companies still offer “defined-contribution retirement plans” for their employees. But in this era of cutbacks and downsizing, some companies have begun diminishing, or even completely eradicating, retirement benefit plans.

So, if you are lucky enough to work for an employer that offers retirement benefits, especially if they offer to match whatever funds you contribute, celebrate your good fortune and pony up as much cash as you can. Let's review the types of employer-sponsored plans, and their benefits or drawbacks (which will be few).

401(k) and 403(b) Plans

401(k) and 403(b) plans are employer-sponsored savings plans that allow you to save current income without paying current taxes on the savings. 401(k) plans are offered by private companies; and 403(b) plans are offered by public, educational, and nonprofit organizations.

Employers typically offer 401(k) and 403(b) retirement plans as an employee benefit. Basically, the employer deposits additional income into a 401(k) or 403(b) retirement plan and uses a “plan provider” to invest the funds on your behalf. The income and the return on investment are not taxed until you withdraw the funds.

Also, and even more importantly, particularly in the case of 401(k) plans, many employers offer “matching contributions” up to a certain level. For instance, an employer may pay 50 cents for every dollar you put into the plan, until your contributions reach 10 percent of your annual salary. Your employer's matching contributions are also not taxed until you withdraw the retirement funds. Your employer will typically require that you stay with the company for a certain time before your funds are “fully vested,” or become 100 percent yours.

When you change employers, you can transfer the retirement funds tax-free to a new employer's 401(k), 403(b), a state or local government deferred compensation plan (457 plan), or to a new IRA. Maximum contribution levels can be as high as 100 percent of your income in a given year, up to $40,000 — unless your income lands you in the top 20 percent salary-wise at your firm. If so, there are special rules for “highly compensated employees” that become applicable.

Each plan may offer investing choices — usually stock, bond, and money market mutual funds. However, you can frequently trade individual stocks, bonds, and other mutual funds by using the plan's “brokerage window” option. However, you may be assessed fees for this option.

Plans are regulated by the Employee Retirement Income Security Act (ERISA), which means that employers and financial institutions providing investment options and administration (the “plan provider”) have a fiduciary responsibility to act in your best interest.

In reality, this means that you will receive at least a summary of the retirement plan and annual account updates. Most plans now go beyond the minimum, allowing Internet access to current plan values and information about investment returns.

These company-sponsored retirement plans have additional very attractive features:

• Employers can direct deposit all contributions — what you don't see, you don't miss, and can't spend.

• Unless you owe money to the IRS, or to an ex-spouse as part of a court-brokered divorce settlement, your creditors generally cannot touch your 401(k) funds if you declare personal bankruptcy.

• You may be able to borrow funds from the plan, allowing you to access the plan's value before retirement (borrowing from retirement plans will be discussed in depth later in this chapter).

Although they are largely good, 401(k) and 403(b) plans do have some limitations. For example, your 401(k) plan may charge administration fees on top of the fees levied by the mutual funds offered within the plan (usually less than 1 percent of your assets), which will reduce your financial returns. Plans with fewer than 100 participants may be assessed “wrap fees,” which at the high end can reach 1.5 percent of assets per year — compromising your ability to grow your retirement assets.

Also, your employer may not make its matching contributions until the end of the relevant year's tax-filing deadline, which means you may wait for matching contributions until the second half of the year following the year you made the related contribution. The sooner the funds are deposited, the sooner you begin earning additional money.

Some of the other “negatives” include these:

• If you withdraw funds prior to age 59.5, you will pay a 10 percent early withdrawal penalty, plus taxes on the amount as “ordinary income.” The taxes and penalty can easily absorb 40 percent of your funds. At age 59.5, you can withdraw funds without incurring penalties, but you will still owe taxes.

• If you are one of the highest paid employees at your firm, falling within the top 20 percent, you are considered a “highly compensated employee” and are limited to contributing up to 2 percent of your gross income over what the lowest 80 percent of wage earners in your firm contribute on average as a percent of their gross income.

  For instance, if the lowest-paid 80 percent of employees at your firm contribute an average of 5 percent of income to their 401(k) plans, you would be able, as a highly compensated employee, to contribute 7 percent or less of your gross income.

• If you belong to a union that hasn't specifically negotiated for members' access to the plan, you can't join your employer's 401(k) plan. Some plans also exclude hourly workers, temporary employees, non-resident aliens, and those under 21 years of age.

Finally, 401(k) plans are limited by the documents your employer created to govern the plan. Limitations may include your inability to borrow against your account and trade individual stocks and bonds. You can lobby your employer to change the plan's features, but your employer controls the outcome of requests for change.

Vesting Periods

Your 401(k) or 403(b) plan will come with a vesting period, which is the time period over which you earn ownership to the matching contributions your employer has made to the account. Any funds you contribute are automatically yours. There are two types of vesting periods. “Cliff vesting” means you receive full ownership of matching contributions at one time; “graduated vesting” gives you ownership of a certain percent of matching contributions each year.

Typically, graduated vesting means that you acquire ownership in incremental percentages according to the length of employment. Laws regulate the minimum amount of vesting of matching contributions: Cliff vesting must happen within three years of the matching contribution, and graduated vesting must start within two years and be complete within six years.

For instance, your employer may offer a 401(k) plan with graduated vesting that happens evenly over five years. This means that if you leave the employer three years after your employer makes a matching contribution to your 401(k), you are able to transfer 60 percent of the employer's matching contribution to the new 401(k), 403(b), 457, or IRA. Even though you don't have full ownership of matching contributions until they vest, you can invest the contributions as soon as they are deposited in your account.

If your employer terminates its 401(k) plan, if you reach the “normal retirement age” defined in the plan (usually 65 years old), if you die or become disabled as defined in the plan, or if your employer lays off 20 percent or more of its employees (including you), your 401(k) funds automatically become fully vested.

Non-matching Contributions

Some employers offer “non-matching contributions,” which means that they establish a set amount of money, usually as a percentage of your salary, that the employer will deposit into your 401(k) or 403(b) retirement plan each year. Your employer would pay non-matching contributions whether or not you contributed to your own 401(k) plan. Non-matching contributions usually take longer to vest — a maximum of five years for cliff vesting plans, and a maximum of seven years for graduated vesting plans.

The maximum amount you can contribute to your 401(k) plan is 15 percent of your annual salary until it reaches a certain number. In 2006, the maximum allowable for employees age 49 years and younger was $15,000, and $20,000 for employees 50 or older. Maximums are adjusted for inflation so they should be reviewed annually.

If your employer makes a contribution to your 401(k), that amount is not added to your contribution when calculating your maximum annual limit, so by all means, contribute as much as you can afford until you reach the limit. Retirement plans are one place where maxing out your options is one of the smartest financial decisions you can make.

Borrowing from a 401(k) Retirement Plan

Many 401(k) plans allow loans, limited by law to a maximum of 50 percent of the employee's vested balance or $50,000 — whichever is lower. Loans must be repaid within five years, usually in equal monthly payments, unless they are for the purchase of your primary residence. If you borrow to buy your primary residence, you may benefit from relatively low loan rates. However, you won't benefit from the tax deductibility of interest on a traditional home loan, and you usually have to repay the loan within 25 years.

As long as you can afford payments, these funds could be used to pay off expensive short-term debts, but you will pay a one-time fee when the loan is made (usually about $50), and may pay annual service fees (also around $50). Interest rates are usually “prime rate” plus 1 percent, with payments deducted from your paycheck.

If you leave, or are fired by your employer, you will have to pay off the loan. If you aren't able to fully pay off the loan, remaining balances will be treated as an early withdrawal from your 401(k), meaning you will pay “ordinary income” taxes and a 10 percent early withdrawal penalty unless you are over age 59.5. Interest on the loan is payable to your account, but you may earn less on your own payments than you would if the funds remained invested in stock and bonds.