Employer-Sponsored Plan (ESP): What it is, How it Works

What Is an Employer-Sponsored Plan?

An employer-sponsored plan is a type of benefit plan offered to employees at no or relatively low cost. These plans, such as a 401(k) or HSA, cover an array of services including retirement savings and healthcare. Employees who enroll in such programs capitalize on the benefit of receiving discounted services. 

On the other hand, employers offering these plans typically benefit from tax breaks. Also, sponsoring benefits is seen as a way to recruit and retain valuable employees.

Key Takeaways

  • Employer-sponsored plans refer to employee benefits that are offered by an organization.
  • These plans are often tax-advantaged for employees.
  • Sponsorship does not mean that an employer contributes funds to the plans, though they may match certain employee contributions.
  • Employers install these benefit plans in order to attract and retain workers as well as receiving tax breaks and other incentives.

Understanding Employer-Sponsored Plans

Employer-sponsored plans span vast geography of services that include different types of group health care plans and retirement savings plans with tax-preferred advantages.

Employer-sponsored savings plans such as 401(k) and Roth 401(k) plans provide employees with an automatic way to save for their retirement while benefiting from tax breaks. The reward to employees who participate in these programs is they essentially receive free money when their employers offer matching contributions. Due to the rising cost of healthcare services, group health plans are an added benefit for employees who benefit from lower costs.

Tax Advantages of Employer-Sponsored Plans

Contributes to a 401(k) plan, is done using "pre-tax" dollars. Pre-tax means that money flows directly from the paycheck into the plan before the deduction of taxes. As a result, less of your income ends up getting taxed. Assessment of tax is at the point when funds are removed from the account, usually at a lower rate.

With a Roth 401(k), you contribute money to the plan on an "after-tax" basis. After-tax means that cash flows from your check into the plan after tax deductions. The trade-off is that qualified withdrawals later down the road are tax-free. A Roth 401(k) plan is a particularly useful tool if you end up in a lower tax bracket upon retirement. 

Some types of employer-sponsored health care plans also offer certain tax advantages. One example is a Health Savings Account (HSA), which is paired with a high-deductible health plan (HDHP).

An HSA is a type of savings account for qualified medical expenses. Contributions are "pre-tax," interest grows tax-free, and withdrawals made to cover qualified medical costs are tax-free as well. And unlike with Flexible Spending Account (FSA), money in your HSA rolls over from year to year.

Some HSAs function as basic savings accounts bearing interest. Depending on the provider your employer works with, you may direct your money into HSA investment accounts offering different mutual fund options just as you would with a 401(k) plan. However, most companies require a member to invest a set amount into a basic HSA account before directing money to an HSA investment account. In this sense, the HSA works like a 401(k) for medical expenses. Money withdrawn for other purposes is taxed.

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