We’ll cover the following workplace plans in this chapter:
Defined benefit plans are qualified plans where the retirement benefit is defined, but the employer’s contributions can vary over time. The most common type of defined benefit plan is a pension.
Over the past several decades, pensions have fallen in popularity because they can be expensive and unpredictable for employers. Organizations that offer pensions are typically obligated to pay retired employees for life. Employers also commonly require long service periods (often 20 years or more) before an employee becomes eligible for pension benefits.
Qualifying employees usually receive benefits based on their salary during their working years. For example, an organization might offer a retirement benefit equal to 70% of the average of an employee’s top three years of earnings. If an employee’s top three years average $100,000, the employer pays $70,000 (70%) each year for the rest of the employee’s life. Many pensions also include an annual cost-of-living adjustment to help keep up with inflation. Because benefits are tied to earnings, defined benefit plans tend to be most valuable for employees with higher salaries.
When the employee retires, they begin collecting payments from the former employer. Those payments must be made regardless of the employer’s financial condition. Even in a poor business year, the organization still has to pay retirees. This ongoing obligation is a major reason many corporations no longer offer pensions. Government-sponsored employers (such as the military and police) are more likely to continue offering them.
To make sure pension payments can be made, employers must set aside and invest significant amounts of money for future payouts. How much they need depends on factors such as the workforce’s combined salaries and ages. In general, higher salaries and employees closer to retirement require the employer to set aside more. Projections also consider expected investment growth and retirees’ life expectancy to estimate how much the organization will ultimately need to pay.
If projected future payouts exceed the amount set aside, the plan has an unfunded pension liability. If the shortfall isn’t addressed, the employer can eventually become insolvent. Many organizations carry insurance to support pension obligations. If the employer goes bankrupt, the insurance provider takes over the required payouts.
Defined benefit plan payouts are 100% taxable to the retiree as ordinary income.
Defined contribution plans have defined contributions (how much goes in), but the retirement benefit is unknown because it depends on investment performance. Most plans allow employees to contribute a set amount (for example, 7% of salary) and invest those contributions. Employers may also contribute on the employee’s behalf (for example, matching contributions up to 5% of salary). Because investment results vary, the amount available at retirement can vary.
All of the plans discussed in this section share the same general tax structure:
The 401(k) (named after section 401(k) of the Internal Revenue Code) is one of the most common qualified retirement plans. It is available to private (non-government) for-profit employers. Employees can contribute pre-tax dollars for retirement, and employers may match employee contributions, which can accelerate the growth of retirement assets.
In general, current employees can’t withdraw money from a 401(k). A hardship withdrawal may be available in certain situations, but standard distribution rules still apply. If the employee is under age 59 ½, a distribution is generally subject to:
Once the employee is terminated (quits, is fired, or retires), they can access 401(k) funds, though taxes and some penalties may still apply depending on the situation.
The 2026 employee contribution limit for 401(k) plans is $24,500.
A 403(b) plan is similar to a 401(k), but it is used by non-profit organizations, public school systems, and religious organizations. It is sometimes called a tax-sheltered annuity. At retirement, the participant typically has several options, such as taking distributions, rolling the account into another retirement plan, or converting the balance into an annuity that pays income for life.
The 2026 employee contribution limit for 403(b) plans is $24,500.
HR-10 plans, also called Keogh (pronounced key-o) plans, are designed for smaller professional practices (such as a dental office or law firm). The employer (for example, the dentist who owns the practice) has a 2026 contribution limit of $73,500 or 25% of income, whichever is less.
A key rule is that if the employer contributes the maximum amount for themselves, they must also contribute for eligible employees at the same percentage of compensation. For example, if the plan contribution is 25%, the employer must contribute 25% of each eligible employee’s income (such as the dental hygienists).
Profit-sharing plans allow an employer to share a portion of business profits with employees. A company might commit, for example, 10% of profits to be allocated annually to employees’ profit-sharing accounts.
Employees don’t contribute to these plans, and the employer isn’t required to contribute every year. If the business has no profits, there’s nothing to share. Even in profitable years, the employer can choose not to contribute. This flexibility can help employers manage cash flow while still offering an incentive tied to company performance.
Money purchase plans are similar to profit-sharing plans, with two key differences:
For example, a company might contribute 4% of each employee’s salary annually. Some money purchase plans allow employees to contribute in addition to employer contributions. When employee contributions are permitted, they are typically required to be made annually.
Later in this unit, you’ll learn about individual retirement accounts (IRAs). IRAs aren’t always employer-sponsored, but SEP IRAs and SIMPLE IRAs are.
Simplified Employee Pension (SEP) IRAs and savings incentive match for employees (SIMPLE) IRAs are designed for smaller companies. They are similar to Keogh plans, but with minor differences you won’t need for the exam. You shouldn’t expect detailed test questions on their contribution limits, but you should know that their limits are higher than traditional and Roth IRA contribution limits (discussed later).
Non-qualified plans are not governed by the Employee Retirement Income Security Act (ERISA). That means they don’t have to follow the same rules that apply to qualified plans (covered in the previous chapter).
A major feature of non-qualified plans is that employers can discriminate in who receives them. Qualified plans generally must be offered broadly to eligible full-time employees. Non-qualified plans, by contrast, can be offered only to selected employees, such as executives, officers, or directors.
A common type of non-qualified plan is a deferred compensation plan. These plans promise compensation in the future and are typically offered to higher-level employees with large salaries.
For example, if an employee earns $500,000 per year, they might defer $100,000. The deferred amount can be invested, and the employee receives the original deferred compensation (the basis) plus any growth later, often in retirement. The employee generally pays taxes when the compensation is received, not in the year it is deferred, which can reduce taxable income in the deferral year.
A 457 plan is a non-qualified plan available to government employees and certain non-profit organization employees. It is unusual among non-qualified plans because it allows tax-deductible contributions and tax-deferred growth.
Unlike most other retirement plans, 457 plans do not impose early withdrawal penalties.
The 2026 contribution limit for 457 plans is $24,500.
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