The Benefits of Automatic Contributions
When we decide when and how much we’re going to contribute, we may fall prey too much to setting this goal aside to some extent and spend the money on something else. Having automatic deductions makes this a lot easier, and while we still can make changes to this, it at least is more difficult to get off course than if we just manually contribute it based upon our own inertia.
While we can easily set up these deductions from our bank account, having our employer do it is an even better idea. While we can’t contribute to an IRA pre-tax like we can with a 401(k), meaning that we will have to pay the tax on these contribution amounts and then deduct the contribution amounts from our taxable income, there is another reason why we may want to consider having our contributions directly go to the IRA out of our pay.
There is a natural tendency to view how much we make by looking at our net pay each pay period, and then use that number to decide how we are going to spend our money and how much we can afford to spend on certain things.
If someone, for instance, ended up with $40,000 after all normal deductions are made, and they look to set up a regular contribution to their IRA out of this, they will see this amount, the $40,000, as the income they have to work with, to deal with everything including IRA contributions.
Our goal, let’s say, is to contribute $5000 a year to our IRA, which will come out of this $40,000. It therefore will often be seen as competing with the rest of this money as far as what we could do with it, and the risk that it will become trumped by something else can be substantial.
If we instead have our employer remit the contributions, they are now paying us $35,000, and this creates a separation between our retirement savings and our other money. While the benefit here is more of a psychological one, we are more likely to resign ourselves to the fact that this $35,000 is what we need to be operating with and this can better condition ourselves to adapt to this.
If we are tempted to make changes, there is at least another degree of separation here. Our own scheduled contributions can be changed without consulting anyone, but if you have to go to your payroll department and submit the change, this can make it less likely that this decision will be made without enough thought, and one needs to own up in a way to the fact that they cannot maintain their desired level of contribution.
Employer remitted IRA contributions can therefore serve to keep us on the right course more, and certainly don’t have any real drawbacks, provided that your employer is willing to do this for you. This is all pretty easy to implement and it’s unlikely that your employer would be unwilling to help you out with this.
The Benefits of Employer IRA Funding
In addition to directing a certain amount of one’s earnings toward an individual retirement plan for the employee, employers may and often do fund contributions into retirement accounts for their employees. Most of these contributions go into a 401(k), but 401(k) plans are not cheap to administer, and some employers opt to go with IRA contributions instead to cut costs and make their plan easier to manage.
Employers cannot contribute to traditional or Roth IRAs, as only planholders can do this, but the IRS has set up a couple of additional types of IRAs to allow this, SIMPLE IRAs and SEP IRAs.
Both of these IRA plans are in lieu of their offering a 401(k) or other major retirement plan, and the goal here is to allow those who work for an employer who has not made any of these arrangements to benefit from additional contributions beyond what a traditional or Roth IRA allow.
While $5500 or $6500 a year, depending on your age, may not be a huge amount to devote to your retirement, it ends up being a significant amount in comparison to the income levels that IRAs permit. If we just set this higher, this often would not mean that people would be contributing more, as these amounts may already be unattainable on one’s own, and most people don’t even contribute to an IRA.
If the employer contributes to one’s IRA though, this can make it easier to get more money in one’s retirement portfolio, even though we know that all employer contributions are factored into one’s total compensation, and employers don’t just throw money at us without proper accounting.
It can be to the employer’s advantage to pay out part of one’s compensation in retirement contributions though as opposed to just giving us the money, and therefore this can indeed be more efficient for the employee from a financial standpoint, ending up getting more compensation overall than otherwise.
The main feature of employer contributions is that it further distances the contribution from the real source, the employee’s labor, and this makes it even easier, a lot more so, to stay on course.
Employer funded IRAs also involve higher limits than we see with traditional and Roth IRAs, and this can allow for a more substantial amount of money saved and shielded from taxes until retirement.
These IRAs work in a similar way to traditional IRAs, other than one’s employer contributing some or even all of the funds that go into the plan.
SIMPLE and SEP IRAs
SIMPLE IRAs are designed for companies of modest size, being limited to those who have 100 employees or less. The idea here is that employers larger than this should set up a 401(k) instead, but for smaller ones, the reduced cost of setting up a SIMPLE IRA may be more appealing.
SIMPLE IRAs allow employers to match up to 3% of an employee’s income, where the employee contributes a certain amount and the employer contributes a similar one, up to these limits. Employers may also choose to simply make a contribution of up to 2% themselves, regardless of how much the employee contributes, if any.
While the contribution limits of a SIMPLE IRA are less than a 401(k), they are considerably larger than with traditional or Roth IRAs. Employees can contribute to $12,500 per year if they are under 50, and $15,500 if they are over 50.
This is about twice as high as individual IRAs, and provide ample room for most people to contribute all they can. Given that employers will match this, this can really propel one’s retirement savings versus traditional or Roth IRAs and also allow those who make incomes that cannot qualify for a regular IRA to be accommodated.
SEP IRAs allow for even bigger contributions to an IRA, where an employer can contribute up to 25% of an employee’s earnings into one, and can contribute up to $55,000 as of 2018. This is a very significant amount of relative contribution, and while of course this all does get factored into one’s total compensation, it is not at all transparent and the employee will usually consider this to be a sort of gift from the employer, or at least an additional benefit over and above one’s pay.
SEP IRAs are also designed to be used by smaller businesses as well as individuals who are self-employed. There are a number of rules surrounding both of these employer sponsored IRAs, but individuals need not concern themselves with them, as the employer will and must administer the plan and will take care of everything.
Employer funded IRAs do serve to deflect a certain portion of one’s compensation toward a retirement plan, and do so in a way that does allow their employees to better succeed in saving for retirement. Due to the way these plans are laid out, they tend to be very well received by employees, and many people will use this as a deciding factor in which employer to work with when job seeking or looking to explore other opportunities.
If one is self-employed, this also allows one to contribute much larger amounts than traditional and Roth IRAs allow, up to 10 times as much in fact.
Traditional and Roth IRAs are actually seen as an adjunct to employer sponsored retirement plans, and while some may have no alternative but to go with them, if one wishes to contribute or to have contributed on their behalf more than the $5500 or $6500 that you can put into these IRAs a year, a work sponsored retirement is needed.
Some work sponsored retirement plans may be out of reach for your employer, so SIMPLE and SEP IRAs serve to bridge the gap here, and permit even the smallest employers, even a self-employed individual with no employees, to take advantage of these additional retirement benefits and have their people saving considerably more for their retirement than would be otherwise attainable.