There are countless ways to save for retirement, each with their benefits and drawbacks. What I want to focus on are a few defined contribution plans you’ll find in the workplace today. A Defined Contribution Plan is a type of retirement plan in which the employer or the employee (or both) make contributions to on a regular basis. Some employers might offer multiple options to their employees, but typically certain qualifications must be met in order to take part in a specific plan.
Defined Benefit Pension Plan
Although they are considered outdated now, Defined Benefit Pension Plans (or “traditional retirement plans”) were the most popular form of employer-sponsored retirement plans available for a long time. Essentially what this plan incorporates is a fixed monthly benefit supplied by the employer starting at retirement. The amount of the pension is determined based on salary and years of service, and since the plan is administered by the employer, the employee will have no control over investment decisions.
Traditional 401(k) Plan Vs. Roth 401(k) Plan
With both types of 401(k) plans, money is withheld from each paycheck and placed in the appropriate account. The difference between the two is at what point the money is taxed. A traditional 401(k) does not tax the contributions each pay period, but rather when the money is withdrawn during retirement. A Roth 401(k) plan, on the other hand, takes out taxes upfront so when you can make tax-free withdrawals during retirement. Put simply, a Traditional 401(k) taxes on distributions, and a Roth 401(k) taxes on contributions.
Another name for a 403(b) Plan is a tax-sheltered annuity (TSA). Essentially this retirement plan is directed toward employees of government and tax-exempt organizations, such as public schools, libraries, hospitals and religious groups. Other than who is eligible to enroll in each plan, 403(b)s function a lot like a traditional 401(k) plan and can even be offered in a Roth version sometimes. However, 403(b)s generally offer limited investment options.
The Savings Incentive Match Plans for Employees Plan, known more commonly as the abbreviation SIMPLE Plan, is a form of retirement investing geared toward smaller companies. SIMPLE plans are designed for companies with 100 or fewer employees who make $5,000 or more per year. It’s more cost effective than a traditional 401(k) plan, and because of this has less flexibility. There is no Roth option, and generally employees utilizing a SIMPLE plan cannot invest as much money as they might with a traditional 401(k).