What is an Employee Savings Plan
An employee savings plan is a pooled investment account provided by an employer that allows employees to set aside a portion of their pre-tax wages for retirement savings or other long-term goals such as paying for college tuition or purchasing a home. Many employers match their employees' contributions up to a certain dollar amount, or by a certain percentage.
BREAKING DOWN Employee Savings Plan
Employees are always fully vested in their own employee savings plan (ESP) contributions. However, many plans require that employees remain employed for a minimum amount of time before they are vested and eligible to withdraw employer-matched funds. ESPs can be an attractive and relatively easy way for employees to lower their taxes and save for long-term goals. In fact, with the phasing out of corporate defined benefit pension plans, ESPs are becoming the sole option for individuals to save for retirement through their employer.
ESPs mostly support saving for retirement and come in two main forms: defined contribution plans or DC plans offered by corporations, known as 401(k) plans, and those offered by public or non-profit entities, known as 403(b) or 457(b) plans. Contributions to both types of plans are made through payroll deductions that lower employees’ taxable income. In addition, contributions and investment profits grow tax-deferred until the funds are withdrawn. For 2018, employees can contribute up to $18,500 to a 401(k) plan while those over 50 can add an additional catch-up contribution of $6,000. Employer matching contributions do not count against this total.
DC plans also offer portability, meaning an employee who switches jobs can either roll over their plan balance into an identical plan at their new employer or transfer the balance into an individual retirement account (IRA) that they maintain on their own. Assets in an IRA also grow tax-free until withdrawn but are subject to lower annual contribution limits than DC plans. For 2018, employees can contribute $5,500 to an IRA or $6,500 if over 50.
Less Common Employee Savings Plans
In addition to or in place of DC plans, some employers offer profit-sharing plans whereby the employer makes an annual or quarterly lump sum contribution into a tax-deferred account that could be a 401(k). These plans are usually subject to vesting schedules but have potentially much higher contribution limits than DC plans.
Non-qualified deferred compensation plans, although less common, are another way for highly compensated employees to save for retirement or other financial goals. These plans allow participants the opportunity to make pre-tax contributions up to 100% of their annual compensation but are typically reserved for a limited number of high-earning employees within a company. They offer greater flexibility than DC plans in terms of withdrawals for college or other non-retirement goals but do not carry the same protections as qualified plans.