We’ll cover the following workplace plans in this chapter:
Defined benefit plans are qualified plans where the retirement benefit is specifically defined, but the employer’s contributions can vary over time. The most common 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. In many plans, an employee needs a long service period (often 20 years or more) to become eligible for pension benefits.
Qualifying employees usually receive benefits based on salary earned during their working years. For example, a plan might pay 70% of the average of an employee’s top three earning years. If an employee’s top three years average $100,000, the pension would pay $70,000 (70%) each year for 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.
Once the employee retires, payments begin. The employer must make these payments regardless of the employer’s financial condition. Even in a bad business year, the organization still owes retirees their pension payments. This ongoing obligation is one reason many corporations no longer offer pensions. Government-sponsored organizations (such as the military and police) are more likely to continue offering them.
To make future pension payments, employers set aside and invest significant amounts of money. How much they need depends on factors like the workforce’s 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.
An unfunded pension liability exists when projected future payouts exceed the assets expected to be available. For example, an organization projects $1 million in payouts in 2030 but expects only $800,000 in the pension fund at that time. If the shortfall isn’t addressed, the employer can eventually bankrupt itself. Many organizations carry insurance to support pension obligations. If bankruptcy occurs, 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 but an unknown retirement benefit. In other words, participating employees know what goes into the plan, but the amount available at retirement 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, such as matching employee contributions up to a stated percentage (for example, up to 5% of salary). Because the account value depends on investment results, the retirement benefit can vary.
All of the plans discussed in this section follow 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’s available to private (non-government) for-profit companies. Employees can contribute pre-tax money for retirement, and employers may match employee contributions to encourage saving.
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, although taxes and some penalties may apply.
The 2026 employee contribution limit for 401(k) plans is $24,500.
A 403(b) plan is similar to a 401(k), but it’s used by non-profit organizations, public school systems, and religious organizations. It’s sometimes called a tax-sheltered annuity.
At retirement, the participant typically has several choices: they can take money from the account, roll it over to another retirement account, or convert it into an annuity that pays income for life.
The 2026 employee contribution limit for 403(b) plans is $24,500.
HR-10 plans, also known as Keogh (pronounced key-o) plans, are designed for smaller professional practices (such as a dentist’s 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.
If the employer makes the maximum contribution to their own plan, they must also contribute to employees’ plans (for example, dental hygienists) at the same rate - equal to 25% of each employee’s income.
Profit-sharing plans work the way the name suggests. A business commits to sharing a stated percentage of profits with employees each year. For example, a company might commit 10% of its profits to employees’ profit-sharing plan accounts.
Employees do not contribute to these plans, and employers are not obligated to contribute every year. If the business has no profits, there’s nothing to share. Even if the company is profitable, the employer can choose not to contribute in a given year. 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, but plans that do typically require employee contributions 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’re 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 discussed in the previous chapter.
One advantage of not being ERISA-governed is that employers can discriminate, meaning they can choose who is offered the plan. Qualified plans generally must be offered to all full-time employees, but non-qualified plans can be offered only to executives, officers, directors, or any other selected group.
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, invest those funds, and then receive the basis (the amount deferred) plus any growth in retirement. The employee generally pays taxes on the compensation when it’s received later, which reduces taxable income in the year the salary is deferred.
A 457 plan is a non-qualified plan available to government employees and certain non-profit organization employees. It’s unusual among non-qualified plans because it allows tax-deductible contributions and tax-deferred growth.
Unlike most other retirement plans, early withdrawal penalties do not apply to 457 plans.
The 2026 contribution limit for 457 plans is $24,500.
When retiring or leaving a job with a qualified plan, many investors roll their plan assets into an IRA. A transfer from one retirement account to another (a rollover) is not taxable. In general, investors have 60 days from receiving a distribution to complete a tax-free rollover into another plan.
Rollovers help investors keep assets tax-sheltered and can provide more investment choices. Many qualified plans limit the types of investments available. IRAs are generally prohibited from short sales, margin, and some option strategies* with unlimited risk potential.
*In particular, an investor cannot sell uncovered (naked) options due to the significant risk involved.
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