What Is an Employee Savings Plan (ESP)?

Employee Savings Plans Explained

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An employee savings plan (ESP) is a type of employer-sponsored plan used to fund retirement and other savings goals. With an ESP, your employer deducts contributions from each of your paychecks and puts that money into a designated account. In some cases, your employer may even match your contributions.

Two popular ESPs are 401(k)s and 403(b)s. Because they’re the most common way to save for retirement and reduce your taxable income, understanding how ESPs work and the different types available to you can help you maximize your options.

Definition and Examples of an Employee Savings Plan

An ESP is an employer-sponsored plan that allows you to set aside a portion of your income for things such as retirement, medical expenses, a down payment on your first house, or other goals. Although primarily funded with pre-tax dollars, ESPs can be funded with after-tax dollars if using a Roth account.

  • Acronym: ESP
  • Alternate name: Employer-sponsored savings plan, salary-deferral plan

Some common examples of ESPs include:

  • 401(k)s
  • 403(b)s
  • 457(b)s
  • Thrift Savings Plans (TSPs)
  • Health savings accounts (HSAs)
  • Flexible spending accounts (FSAs)
  • Profit-sharing plans
  • Defined benefit plans

How Does an Employee Savings Plan Work?

Employers offer ESPs as part of their benefits package to incentivize employees to save for long-term goals such as retirement and health care expenses.

Your employer typically deducts your ESP contributions from your paycheck each period; you don’t have to set aside this money yourself. That amount gets deducted from your gross income at the end of the year when you file your taxes. The only exception is if you have an after-tax, or Roth, ESP. In this case, you won’t get a tax break until you start taking withdrawals.

All the money you contribute to your ESP is immediately yours. If you leave the company, you can take it with you or roll it into another account. However, any matches your employer makes may be subject to certain vesting schedules.

For example, let’s say your employer offers a 401(k) where they’ll match up to 5% of your salary. You make $100,000 a year. You really want to retire early, so your goal is to save the maximum amount, which is $19,500 for the year.

You elect to have 19.5% of each paycheck directed to your 401(k). Your employer matches your contributions dollar for dollar, up to 5% of your salary. At the end of the year, you have $24,500 in your 401(k); you contributed $19,500, and your employer contributed the other $5,000.

Now let’s say your company has a vesting schedule that says you get 50% of your employer match after one year of service and 100% after two years. If you leave your company after one year, you walk away with $22,000 (your full $19,500 plus 50% of what your employer contributed). If you stick it out for two years, you keep the entire $24,500 plus any additional contributions you make that second year.

Types of Employee Savings Plans

Most ESPs are used for retirement, but a few are intended specifically for medical expenses.

401(k)

401(k)s are the most common type of ESP, giving employees a way to build up a sizable nest egg for retirement. Many employers even offer 401(k) matches, where they’ll match your contributions up to a certain percentage. Employees who have access to a 401(k) can save up to $19,500 for 2021. Those ages 50 and older save up to $26,000.

403(b)

A 403(b) is a type of ESP only available to employees of tax-exempt organizations, such as nonprofits, churches, hospitals, public schools, and universities. Similar to a 401(k), it’s used for retirement savings and allows for an employer matching program.

457(b)

A 457(b) is similar to a 401(k) or 403(b), but it’s only available to state and local government employees. This type of account allows employees to save for retirement and has one unique benefit not found with other ESPs: Generally, if you leave your job before age 59 ½ and need to withdraw your funds, you won’t pay a 10% penalty.

Thrift Savings Plan (TSP)

A Thrift Savings Plan (TSP) is similar to a 401(k), but it’s only available to federal employees through the U.S. government. This type of ESP allows eligible employees to set aside a portion of their income for retirement using either a traditional (pre-tax) or Roth (after-tax) account.

Health Savings Account (HSA)

Health savings accounts (HSAs) are a type of ESP that allows you to set aside part of your paycheck for qualified medical expenses. You fund them with pre-tax dollars, and you enjoy tax-free withdrawals when you use the money to cover health care costs.

You may be eligible for an HSA if you have a high-deductible health care plan (HDHP) and no other insurance coverage. Some employers even match contributions the same way they do with 401(k)s.

Flexible Spending Account (FSA)

Flexible spending accounts (FSAs) are similar to HSAs in that they’re both a type of ESP used for medical expenses. The difference, however, is that you don’t have to have a high-deductible health care plan to qualify for an FSA. On the downside, FSA funds don’t roll over year to-year (you either use them or lose them).

Under the COVID-related Taxpayer Certainty and Disaster Tax Relief Act of 2020, employers are allowed to let employees roll over unused funds from the 2020 and 2021 plan years into 2022.

Profit-Sharing Plan

Many employers offer a 401(k) in conjunction with a profit-sharing plan. The difference is, employees don’t contribute to a profit-sharing plan. Instead, you earn shares of profit in the form of cash or stock based on company performance.

Defined Benefits Plan

Defined benefit plans, also known as pension plans, are far less common today than they used to be. With a defined benefit plan, you’re paid a set income in retirement. These kinds of plans are usually employer-funded rather than employee-funded.

Pros and Cons of an Employee Savings Plan

Pros
  • Get an immediate tax break

  • Higher contribution limits

  • Easy way to save for retirement and medical expenses

  • Some employers match contributions

Cons
  • May pay taxes on withdrawals

  • Early withdrawal penalties may apply

  • Must be vested to keep employer contributions

Pros Explained

  • Get an immediate tax break: Unless you opt for a Roth account, which uses after-tax dollars, you’ll fund your ESP with tax-deferred contributions. This deferral lowers your taxable income for the year.
  • Higher contribution limits: Unlike individual retirement accounts (IRAs), which have contribution limits of $6,000 per year for 2021, 401(k)s, 403(b)s, 457(b)s, and TSPs let you save up to $19,500. Those ages 50 and older can save up to $26,000 thanks to catch-up contributions.
  • Easy way to save for retirement and medical expenses: ESP contributions get automatically deducted from your paycheck, which means you can save each month without lifting a finger.
  • Some employers match contributions: Some employers will match your ESP contributions up to a certain dollar amount or percent. This is 100% free money and doesn’t count toward your contribution limits for the year.

Cons Explained

  • May pay taxes on withdrawals: Unless you have a Roth ESP, you’ll pay taxes on your money when you start taking withdrawals. You may also have to take required minimum distributions (RMDs) at age 72.
  • Early withdrawal penalties may apply: Because of the tax benefits, many ESPs penalize you if you withdraw money early (such as with retirement accounts) or don’t use the funds for their intended purposes (such as with HSAs and FSAs).
  • Must be vested to keep employer contributions: If your employer offers a matching program for your ESP, you may be required to stick with that company for a set number of years before you’re “vested” and truly own the money they contribute to your account.

Key Takeaways

  • An employee savings plan (ESP) is an employer-sponsored plan that allows you to set aside part of your paycheck for retirement, medical expenses, and other goals.
  • The most common types of ESPs are 401(k)s and 403(b)s, but they also include 457(b)s, TSPs, HSAs, FSAs, and others.
  • Most ESPs are funded with pre-tax dollars but may be funded with after-tax dollars if you opt for a Roth account.
  • Many employers offer matching programs where they’ll give you free money for contributing to your ESP. But you may have to stay at that company for a set period before you can keep your employer match.