Defined Contribution and 401K (2024)

FAQs

Is a 401k the same as a defined contribution? ›

401(k) plan is a defined contribution plan where an employee can make contributions from his or her paycheck either before or after-tax, depending on the options offered in the plan. The contributions go into a 401(k) account, with the employee often choosing the investments based on options provided under the plan.

Due to IRS employer contribution limits, when you sponsor a defined benefit plan there will be additional limits on employer-based contributions to your other plans. However, you could continue to make 401(k) employee deferrals and catch-up contributions to the old plan(s).

Limited investment options.

Defined contribution plans may offer limited investment choices, depending on the selection of funds an employer offers. If you are unhappy with your plan's investment options, consider saving some of your retirement funds in an IRA, which usually offers more choices.

You can roll a plan into any other qualified plan, such as a 401(k) or even a SEP. A SEP is technically a type of IRA. But many people will still keep a 401(k) open even after they're finished making significant contributions to a defined benefit plan. As such, it can make sense to roll the plan over into the 401(k).

While a 401(k) is the most common type of defined contribution plan, there are other kinds of plans for different types of employers and employees.

Many private-sector employees are offered and participate in a defined-contribution plan. Such plans carry less risk for the employer as they are not responsible for managing the account themselves. They also provide much more flexibility to the employee.

With such high contribution limits, many clients set up a solo or one person defined benefit plan. You can also combine with a 401(k). If structured correctly, these plans are one of the best tools a business owner can use to accelerate retirement savings. But they are complex structures.

Key takeaways

Aim to save at least 15% of your pretax income each year for retirement (including employer contributions).

Fewer companies today offer traditional pensions; however, you can have a pension and still contribute to a 401(k) and an IRA. Contributing to a variety of retirement vehicles can be a smart retirement strategy.

Companies choose defined-contribution plans instead because they are less expensive and complex to manage than pension plans. The shift to defined-contribution plans has placed the burden of saving and investing for retirement on employees.

Why are employers no longer using defined-benefit plans? ›

This is because employer contributions to DB plans may include additional contributions to make up for investment losses, whereas in DC plans employer contributions are typically based on a set formula that uses employee compensation. In addition, DC plans are easier to administer than DB plans are.

The main disadvantage of a defined contribution pension is that it's a finite pot of money that can run out (unless you use it to buy an annuity). Your investments are also subject to stock market performance, meaning that a significant market crash can reduce your retirement savings.

As the name suggests, a DB / DC Combo Plan is when a Defined Benefit Plan is paired with a Defined Contribution Plan, such as a 401(k) Profit Sharing Plan. By combining the two plans, a business owner is able to increase their deductible limit and reduce the cost of providing retirement benefits to employees.

A 401(k) Plan is a defined contribution plan that is a cash or deferred arrangement. Employees can elect to defer receiving a portion of their salary which is instead contributed on their behalf, before taxes, to the 401(k) plan. Sometimes the employer may match these contributions.

You can't withdraw the money in a DCPP before you retire (age 55 or older). However, there are some instances where withdrawals may be permitted by law. With a DBPP, if you leave your employer before you retire, you can take the commuted value of your pension out and invest it yourself, in a locked-in account.

A 401(k) Plan is a defined contribution plan that is a cash or deferred arrangement. Employees can elect to defer receiving a portion of their salary which is instead contributed on their behalf, before taxes, to the 401(k) plan.

401(a) plans are employer-sponsored defined contribution retirement plans available to governmental, for-profit and not-for-profit employers.

Defined Contribution Funds

These funds are known as "money purchase" or "fixed contribution" funds. The rules of the fund, specify the contributions to be paid by the employer and member, but does not guarantee the retirement benefit.

Once your pension benefits are locked in, you generally cannot withdraw funds from the plan as a cash payment. Contributions that your employer makes to a DC plan are deductible to the employer and are not considered a taxable benefit to you.