Employer-sponsored Plans
There are various employer-sponsored retirement plans, including defined benefit and defined contribution plans. We explain the key features and tax treatments of each plan type, highlighting the benefits of options like traditional and Roth 401(k)s. Understanding these plans and how they work is essential for making informed decisions about your retirement savings.
Employer-sponsored retirement plans are plans that are made through your job. These plans fall into two categories: defined benefit plans and defined contribution plans.
Defined Benefit Plans
Defined benefit plans give you a specified monthly benefit at retirement. This benefit can be a fixed dollar amount or may depend on a plan formula that considers factors such as your salary and years of service to the company. These plans are also known as pension plans.
Defined Contribution Plans
Defined contribution plans do not promise you a specific payment upon retirement. Instead, you or your employer, or both, contribute to your individual account under the plan, sometimes at a set rate, such as 5% of your annual salary. A 401(k) plan is an example of this. Once you retire, you receive the balance of the account, which depends on contributions plus or minus investment outcomes.
401(k) Plans
401(k) plans are a common type of defined contribution plan, and there are two main types: traditional 401(k) and Roth 401(k). Both offer tax advantages but differ in when you pay taxes.
Traditional 401(k)
A traditional 401(k) gives employees a choice of investment options. Any contributions and investment earnings are tax-deferred, meaning you pay taxes on the savings when you withdraw them. Some employers will match a portion of an employee’s 401(k) contributions, meaning if you contribute to the account, your employer will also contribute a certain amount.
Roth 401(k)
A Roth 401(k) is similar to a traditional plan except that employee contributions are not tax-deferred but are made with after-tax money. Income earned on the account is tax-free because the money you’ve put into it has already been taxed.
The main difference is that traditional 401(k)s are tax-deferred and Roth 401(k)s are not.
403(b) and 457(b) Plans
403(b) and 457(b) Plans are tax-deferred retirement savings programs provided by certain employers.
403(b) plans are offered by public educational institutions such as public schools and colleges, certain non-profits, and churches.
457(b) plans may be offered by state and local government agencies and certain non-profit organizations.
Comparison Chart: Employer-Sponsored Retirement Plans
Plan Type | Features | Tax Treatment | Typical Employers |
Defined Benefit Plan | Fixed monthly benefit at retirement | Taxable upon receipt | Various companies (often larger firms) |
Defined Contribution Plan | Contributions by employee and/or employer | Depends on plan type | Various companies |
Traditional 401(k) | Tax-deferred contributions, employer matching | Taxed upon withdrawal | Private sector companies |
Roth 401(k) | After-tax contributions, tax-free withdrawals | Tax-free withdrawals | Private sector companies |
403(b) | Tax-deferred, similar to 401(k) | Taxed upon withdrawal | Public schools, colleges, non-profits |
457(b) | Tax-deferred, similar to 401(k) | Taxed upon withdrawal | Government agencies, some non-profits |
Understanding the various retirement plan options and their tax treatments can help you make informed decisions about your retirement savings strategy. In the next modules, we will delve deeper into these plans, compare them, and explore other important aspects of retirement planning.