What Is an Employee Savings Plan (ESP)?
An employee savings plan (ESP) 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. The most popular ESP in the U.S. is the 401(k) retirement plan.
- Employee Savings Plans (ESPs) are employer-sponsored savings and investment plans that allow employees to make contributions using pre-tax dollars for specific purposes.
- 401(k) retirement plans allow employees to save up to $19,500 a year for retirement, sometimes with additional contributions made by an employer match.
- Health savings accounts (HSAs) are another type of ESP intended for health expenses.
How Employee Savings Plans Work
Employees are always fully vested in their own employee savings plan 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In addition, contributions and investment profits grow tax-deferred until the funds are withdrawn.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 2020, employees can contribute up to $19,500 to a 401(k) plan (up from $19,000 in 2020) while those over 50 can add an additional catch-up contribution of $6,000. Employer matching contributions do not count against this total.
Other Key Components
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 Assets in an IRA also grow tax-free until withdrawn but are subject to lower annual contribution limits than DC plans.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 2020, employees can contribute $6,000 to an IRA or $7,000 if over 50.
A Health Savings Account (HSA) is another example of an ESP. These tax-advantaged accounts were created for individuals who are covered under high-deductible health plans (HDHPs) to save for medical expenses that HDHPs do not cover. Contributions are made into the account by the individual or the individual's employer and are limited to a maximum amount each year. The contributions are invested over time and can be used to pay for qualified medical expenses, which include most medical care such as dental, vision, and over-the-counter drugs.
Less Common Employee Savings Plans
In addition to or in place of DC plans, some employers offer profit-sharing plans in which 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, though 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.