What is a Defined Contribution Plan, and How Does it Work?

Shawn Plummer, CRPC

Chartered Retirement Planning Counselor

Defined Contribution Plan Calculator

Use this defined benefit plan calculator to watch your retirement savings grow.

What is a Defined Contribution Plan?

A defined contribution plan is a retirement plan where both the employee and employer contribute fixed amounts. The final benefit depends on the plan’s investment performance. Unlike defined benefit plans, these don’t promise a specific payout at retirement.

What Is A Defined Contribution Plan

Types of Defined Contribution Plans

  1. 401(k) Plan
    • Employer: Often private sector.
    • Contributions: Pre-tax or Roth, employee-elected, employer matching possible.
    • Investment Choices: Varies, often include mutual funds, stocks, and bonds.
    • Withdrawal Rules: Penalty for early withdrawal, required minimum distributions after age 73.
  2. 403(b) Plan
    • Employer: Non-profits, schools, religious groups.
    • Contributions: Similar to 401(k), with some variations in limits and rules.
    • Investment Choices: Annuities, mutual funds.
    • Withdrawal Rules: Similar to 401(k), but may have different rules for hardship withdrawals.
  3. 457 Plan
    • Employer: Government and some non-profit employers.
    • Contributions: Pre-tax, similar to 401(k) and 403(b).
    • Investment Choices: Depends on the plan provider.
    • Withdrawal Rules: No early withdrawal penalty, but taxes apply.
  4. Thrift Savings Plan (TSP)
    • Employer: Federal employees and military members.
    • Contributions: Similar to 401(k), including Roth options.
    • Investment Choices: Limited selection of funds.
    • Withdrawal Rules: Similar to 401(k), with specific rules for federal employees.
  5. Solo 401(k) Plan
    • Employer: Self-employed individuals with no employees.
    • Contributions: Higher contribution limits, including employer and employee contributions.
    • Investment Choices: Wide range, similar to traditional 401(k).
    • Withdrawal Rules: Similar to standard 401(k) plans.
  6. Simplified Employee Pension (SEP) IRA
    • Employer: Self-employed, small business owners.
    • Contributions: Employer only, up to a certain percentage of income.
    • Investment Choices: Similar to Traditional IRA.
    • Withdrawal Rules: Standard IRA rules apply.
  7. Savings Incentive Match Plan for Employees (SIMPLE) IRA
    • Employer: Small businesses with 100 or fewer employees.
    • Contributions: Employee and employer contributions.
    • Investment Choices: Similar to Traditional IRA.
    • Withdrawal Rules: Similar to traditional IRAs, with additional early withdrawal penalties.

Contribution Limits and Employer Matching

Plan TypeContribution Limit 2024Employer Match
401(k)$23,000Varies
403(b)$23,000Varies
457 Plan$23,000Varies
TSP$23,000Up to 5%
Solo 401(k)$69,000Up to 25%
SEP IRALesser of $69,000 or 25%Not Applicable
SIMPLE IRA$16,000Up to 3%

Conclusion

Defined contribution plans are essential for retirement planning, offering various options suited to different employment types. Understanding the specifics of each plan helps in making informed decisions for financial security in retirement.

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Frequently Asked Questions

What’s the difference between a defined contribution plan and a defined benefit plan?

A defined benefit plan promises a specific payout upon retirement, while a defined contribution plan does not guarantee a specific payout.

How much should I contribute to my defined contribution plan?

It’s best to contribute as much as you can afford, and at a minimum, you should aim to contribute enough to take advantage of any employer matching program.

Can I withdraw funds from my defined contribution plan before retirement age?

In most cases, you can withdraw funds from your defined contribution plan before retirement, but you’ll likely face penalties and taxes.

Shawn Plummer, CRPC

Chartered Retirement Planning Counselor

Shawn Plummer is a Chartered Retirement Planning Counselor, insurance agent, and annuity broker with over 14 years of first-hand experience with annuities and insurance. Since beginning his journey in 2009, he has been pivotal in selling and educating about annuities and insurance products. Still, he has also played an instrumental role in training financial advisors for a prestigious Fortune Global 500 insurance company, Allianz. His insights and expertise have made him a sought-after voice in the industry, leading to features in renowned publications such as Time Magazine, Bloomberg, Entrepreneur, Yahoo! Finance, MSN, SmartAsset, The Simple Dollar, U.S. News and World Report, Women’s Health Magazine, and many more. Shawn’s driving ambition? To simplify retirement planning, he ensures his clients understand their choices and secure the best insurance coverage at unbeatable rates.

The Annuity Expert is an independent online insurance agency servicing consumers across the United States. The goal is to help you take the guesswork out of retirement planning and find the best insurance coverage at the cheapest rates

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