Why participate in a salary deferral plan? | American Funds

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About retirement plans


Retirement Planning

Why participate in a salary deferral plan?

A salary deferral plan lets you shape your own retirement savings program so you can think beyond Social Security. Here are three reasons to participate in the plan:

Everybody loves a tax break

There are two basic types of retirement plan contributions, each offering a different way to get a tax benefit.

  • Traditional contributions: You’re getting a tax break up front with traditional contributions because the money going into your account has not been taxed. By postponing taxes until you take withdrawals, you have more money working for you.
  • Roth contributions: Money going into a Roth account is taxed before you invest it, but qualified withdrawals, including any earnings, won’t be taxed.*

In addition, retirement plan earnings aren’t taxed every year, so you could benefit from having more money in your account growing through compounding. Check with your employer to find out which contribution types your plan offers.

The chart below shows the hypothetical growth over 30 years of a traditional, tax-deferred investment compared with a taxable account.

The tax-deferral advantage

tax-deferral-advantage

1 The use of an 8% annual return (compounded monthly) relates in no way to the actual results of any mutual fund. Your investment experience will differ. Results shown for the taxable investment assume 25% in taxes is paid from the account each month. Lower maximum tax rates on long-term capital gains and qualified dividends could make the taxable investment return higher, thus reducing the difference between the two ending values shown. This chart does not address the impact of Roth after-tax contributions.

2 When you withdraw only a portion of your retirement plan balance, you’ll likely pay less in taxes and continue to have the remaining balance grow tax deferred. However, if you take the $225,044 as a lump sum, you’d be left with $150,779 after being taxed at the 33% rate. (Your actual tax rate may vary.) The money you take out of your plan is subject to ordinary income tax and, if applicable, to an additional 10% federal tax penalty on early withdrawals.

 

A program of regular investing does not guarantee a profit or protect against loss.

You wouldn’t turn down free money

Many companies offer matching funds as an incentive to encourage employees to contribute to their salary deferral accounts. If your employer offers to match your retirement contribution, take it. It’s as if your employer is paying you a bonus — and all you have to do is save in the plan. Contribute at least enough to get the full match. If the match is in company stock, think about diversifying the rest of your account. The match is part of your benefits package. Don’t walk away from it.

Social Security won’t be enough

If you plan to rely on Social Security to pay all your bills, your retirement dreams may need to be trimmed back. The rule of thumb is that Social Security probably represents only 40% of your retirement needs. In 2013, the average monthly benefit for a retired worker was about $1,294. Even with cost-of-living increases, this won’t buy the kind of retirement most Americans dream about. When you participate in your retirement plan, you take control of supplementing Social Security.

retirement-income-sources

Visit the Social Security Administration website for more information about the retirement benefit you can expect.

* Withdrawals from Roth accounts are tax- and penalty-free if the account was established at least five years before, and if the participant is at least 59-1/2 years old, has died or is disabled. For nonqualified distributions, earnings are taxable and may be subject to a 10% early withdrawal penalty.

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Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.

Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional or downloaded and should be read carefully before investing.


Starting early

Starting early can have a big effect on your nest egg. See how