Retirement. We spend the majority of our careers saving for retirement, and it’s often viewed as an exciting next-phase of our lives. It’s a time to travel, pursue hobbies, enjoy family and be around the ones you love. Historically, many workplaces have assisted their employees in saving for retirement with some kind of workplace retirement plan. In the past, an employer defined benefit plan – like a pension – was the typical way that a company could help their employees prepare for retirement.
However, in recent years, the number of companies who actively use a pension plan has declined significantly. The more commonly used workplace retirement plan is a defined contribution plan – like a 401(k) or 403(b).
What’s the Difference?
A company pension is a defined benefit plan, where your employer puts up the money that will act as part of your retirement income. This type of plan tends to be expensive for companies to sustain. As a result, many of them have switched to defined contribution plans to help support their employees in retirement – which are primarily funded by the employees themselves.
Defined contribution plans, such as a 401(k) or 403(b), require employees to invest their own money in their plan and manage those investments according to their risk tolerance. Employees decide on how much they want to contribute, and that amount is deducted from each of their paychecks. In some cases, companies have an employee match program where they contribute their own funds (usually a small total percentage of your salary) to boost your savings over time.
Which is Better?
Many people regret the decline of pension plans in the American workplace. Having a 401(k) or 403(b) can feel overwhelming, especially if you’re not confident in your investment strategy. However, pension plans aren’t always what they’re cracked up to be. Many pension plans that are still functioning in the workplace don’t fully fund an employee’s retirement, and the employees participating in the plan don’t have a lot of say in how their money gets invested.
A defined contribution plan, however, empowers the employees who participate in the plan to make decisions about how their money is invested, and how much risk they want to take on. If your employer has a defined contribution plan, like a 401(k) or a 403(b), there are a few things to keep in mind as you make retirement planning decisions.
Maximize Your Match
A lot of employers have an employee match program for their defined contribution plan. As you decide how much you are contributing to your retirement savings account, the first thing you should consider is how much your employer offers in a matching program.
Most employers will offer approximately a 100% match up to 3% of your total salary, and an additional 50% match for up to 6% of your salary. To maximize the match in this situation, you’d want to contribute a minimum of 6% of your paycheck to double your investment. If you don’t choose to take the match, you’re essentially leaving hard-earned money on the table.
Know Your Risk Tolerance
With a defined contribution plan, you’re in charge of managing your own investment portfolio. A large part of this is understanding your risk tolerance to correctly align the investments in your retirement account. Your risk tolerance is comprised of two major factors:
- How much risk your investment portfolio can reasonably handle based on your goals.
- How much risk you can comfortably stomach.
Within your defined contribution plan, you get to decide how your money is invested. When you’re just starting out in your career, you may choose an aggressive investment strategy that offers more growth potential but takes on more risk. If your investments lose money, you have more time to recover. However, if you’re closer to retirement, you may choose a less aggressive investment strategy that doesn’t offer as much growth but takes on less risky funds.
Knowing your risk tolerance is one of the primary ways you can control how your wealth grows. It’s important to remember that everyone’s financial situation is unique, and investing your retirement nest egg in funds that align with your current financial situation as well as your long-term goals can help put you on the path to a financially fulfilling retirement.
Ask for Guidance
Planning for retirement using your defined contribution plan may feel overwhelming. Speaking with a financial planner can help. I help to guide my clients through maximizing their employee benefit plans, and empowering them to take charge of their financial future. If you’re looking for help with your workplace retirement plan, contact me today. I’d love to hear your concerns, and help you build a strategy that supports your retirement goals.