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Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Employee Contribution Plan

What it is:

An employee contribution plan is an employer-sponsored retirement plan where employees deposit (contribute) their own money to a special account.

How it works (Example):

Employee contribution plans are usually funded by contributions that are automatically deducted automatically from an employee's paycheck. The contributions are generally pretax dollars that are transferred to a retirement account like such as a 401(k) Plan or 403(b) Retirement Plan.

To encourage employees to put more of their paycheck into the employee contribution plan, some companies choose to match the contribution amounts of the employee and deposit the funds into the account as well. This company benefit can vary depending on the company; some match a percentage of the employee contributions and others match employee contributions dollar for dollar.

The employee is usually responsible for choosing the investment vehicles in which the contributions are invested (i.e., aggressive-growth mutual funds, government bond funds, the employer's stock, etc.) Because an employee contribution plan is an employee-owned retirement plan, the employee will receive their contributions and earnings when they retire after age 59.5. The withdrawals are generally taxed if the contributions were pretax dollars (see 401(k) Plan).

Why it Matters:

Employee contribution plans are an important benefit that can help employees raise significant amounts of money for retirement.  If the employer matches some or all of the employees' contributions, it can exponentially grow the earnings in retirement funds. Even if the employer does not offer a match, the contributions are still usually made with pretax dollars, which also represents a savings for the employee.

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