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401- What? 457- Who? Understanding Retirement Plan Options

We often get questions from clients wondering what type of retirement plan they have and how their plan is different from all the other plans out there. While it can get confusing, all of these plans are set up with the same basic idea in mind: give employees control over their own retirement savings. So let’s look at the more popular types of plans available for employees.

One quick distinction we need to make is the difference between Defined Benefit plans and Defined Contribution plans. A pension that is provided by an employer would fall under the Defined Benefit plan category. In this case the amount of an employee’s benefit is decided, according to a number of factors, by the employer. The employer will also have complete control over investment risk and the specific investments within the account. While many of you may be eligible for a pension through your employer, these plans are becoming much less common.

Defined Contribution plans are designed to give you, the employee, more freedom and control over the amount you contribute and the selection of your investments. Here are some the most common types of Defined Contribution plans we see:

401(k) – Likely the most recognizable plan type offered by the private sector employers.

  • Name comes from section 401, line k of the IRS tax code, which gives employers the right to establish this plan under specific guidelines.
  • Contributions are voluntary and made through payroll deductions, (percent is chosen by the employee) and are often matched by the employer up to a small percentage of the employee’s salary.
  • Employer selects a list of investment options for the participant to choose from.
  • Participants can choose to contribute pre-tax and, sometimes, after-tax amounts and money grows tax-deferred until retirement.

403(b) – Tax-exempt entities such as local schools, hospitals, and non-profit organizations are eligible to offer this type of retirement plan.

  • Name also comes from its section in the IRS tax code.
  • Usually offered as a supplement to a Defined Benefit pension plan.
  • Unlike a 401(k), these plans often offer multiple providers (Fidelity, TIAA-CREF, Vanguard, etc.) for participants to choose from.
  • Functions much like as a traditional 401(k) with tax-deferred pre-tax contributions and is strictly voluntary. However, it is rare to see an employer match.

457Tax-exempt entities such as local schools, hospitals, and non-profit organizations are eligible

  • Name also comes from its section in the IRS tax code.
  • Usually offered as a supplement to a Defined Benefit pension plan and often offered in addition to a 403(b)
  • Functions exactly as a 403(b) or traditional 401(k) with tax-deferred pre-tax contributions and is strictly voluntary. Employer matching is much more common than with a 403(b), but less common than with a 401(k).
  • Known as a Top-Hat plan since it offers additional deferral when coupled with a 403(b). For example, once contributions are maximized in a 403(b), you can still contribute to a 457, which is ideal for those who have larger amounts of money to contribute.
  • If you continue to work with the employer by which the 457 is offered, you cannot take distributions until age 70½ without being penalized. However, if no longer with the employer, withdrawals can be made without penalty at any age.

Thrift Savings Plan – Offered to all employees of the U.S. Federal Government (civilian or military)

  • Although offered through the Federal Government, the plan functions like a 401(k) from a private employer.
  • Many agencies offer a small match and all employees receive a 1% employer contribution whether they themselves contribute or not.
  • Investment options are limited and are the same for all agencies.
  • As with the 401(k) and 403(b), there are penalties for distributions taken before age 59½.

 

There are more specific details surrounding each type of retirement plan that cannot be covered in one article. Check out Retirement Investing Basics in the Smart401k Education Center. You can find more information on plan types, contribution limits and important terms to keep in mind.

As always, feel free to contact us at info@smart401k.com or 877-627-8401if you have any questions.

 

Andrew Thomas

Smart401k Associate Representative

Nothing in this article should be construed as tax advice. Contact a qualified tax professional to discuss any tax matters relating to your retirement plan investment options.