As the start of a new year approaches, many companies schedule an open enrollment period for their employees to sign up for company-provided benefits. This is your chance to take advantage of everything from retirement plans to health care coverage.
Even though you know your employee benefits are a smart use of your money, one look at the 401(k) or health insurance materials your company provides could make you think twice. Why would you tie up part of your paycheck in these benefits if you can’t even understand the sign-up forms?
The good news is your benefits truly are a smart way to make your money go further, and the process doesn’t have to be confusing. To help you make sense of all the options and decide which are best for you, take a quick look at a few of the most common terms you’ll see this open enrollment season.
Don’t let the numbers and letter distract you—this is just a fancy legal term for a retirement savings plan offered by employers. A few great things about the 401(k) include:
- You get to invest some of your money for the future.
- Your contributions are made automatically with each paycheck—you don’t have to remember to do it.
- Investing in your 401(k) lowers your taxable income, allowing more of your hard-earned dollars to grow over your career.
- Many companies even match a portion of your contributions. That’s free money and a guaranteed 100% return on your investment. You won’t get that kind of deal anywhere else!
Pretax vs. After-Tax
One key question to ask when looking at a retirement plan is whether it will work as a pretax or after-tax benefit. There are advantages to both. To understand the difference, let’s look at how $100 would perform in each.
Most company 401(k) plans are pretax plans, which simply means the taxes on those funds are deferred until the time you withdraw them at retirement. If you take home $100 in pay, it wouldn’t be $100, would it? Because of taxes, that $100 would look more like $75. However, if you put that money in your 401(k), the whole $100 would go into your retirement account because the government doesn’t take taxes out of your contributions. That means you get the biggest bang for your buck now, and you won’t pay taxes on it until you withdraw the money at retirement.
But some companies offer an after-tax plan, or Roth 401(k). What’s the difference? A Roth account grows tax-free. Unlike the regular 401(k), with a Roth you pay the taxes up front. So, instead of the full $100 in the pretax example above, you’d contribute the after-tax amount of around $75. However, you never have to pay taxes on that contribution again! You get fantastic tax-free growth on that money that could save you hundreds of thousands of dollars (or more) at retirement! By paying taxes up front, your retirement savings grow completely tax-free, and you won’t owe anything when you withdraw the money at retirement!
This is an easy term you’ll run into if your company offers health insurance. Your deductible is the amount of money you pay out of pocket toward your medical expenses before the insurance company kicks in its portion.
Your company may offer plans with several deductible options. A higher deductible means you pay less per month for your coverage, but that’s because you’re taking on a higher level of risk. If you run up big medical bills, you’re responsible for paying them until you meet your deductible amount.
Your company may offer some options to help fill the coverage gap left by your deductible.
- A Health Savings Account (HSA) works in combination with a high-deductible health plan. It allows you to save for and pay for medical expenses tax-free. It’s like a tax-sheltered fund you can use to meet that high deductible.
- A Flexible Spending Arrangement (FSA) can be used to pay for the same medical expenses as an HSA, but unlike an HSA, the money in your FSA does not roll over year to year. Also, if you leave your employer, you cannot take your FSA funds with you.
You can use money saved in an HSA or FSA to pay for vision and dental expenses as well.
If your company offers you medical insurance, your coverage will include defined co-payments (or “co-pays”) for various services. This is a specific dollar amount you’re required to pay when, for example, you see your doctor or get a prescription filled. Most providers require you to pay your co-pay at the time of service.
This is the most money you’ll ever be required to pay for health care costs in any given year before the insurance company steps in to pay the full balance. Once you reach your out-of-pocket maximum, the insurance company will pay for 100% of your covered health expenses for the rest of the year.
- This cap protects you, the policyholder, from being totally wiped out in the event you run up huge medical bills.
- Any co-pays or deductible payments you make count toward your out-of-pocket maximum.
Don’t let a few unfamiliar terms stop you from making the most of your employee benefits. They’re valuable tools you can use to protect and grow your money for years to come. If you have more questions about open enrollment, your company’s human resources department is a great place to learn more.