Retirement Plan
Defined Benefit Plan
Defined Benefit (DB) known as a traditional pension, it pays a retiree a specific benefit based on years of service and salary level until they die. In some cases, the payout will continue for a spouse or a beneficiary. The plan is quite costly for the employer. It's called DB as you know what you're going to get when you retire. Companies have stopped providing on these plans, instead of Contributions plan.
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Defined Contributions Plan
Defined Contribution (DC) plans are known by their IRS Tax Code, like 401K,403(b),etc. DC plans allow the employee to make pre-tax contributions to their own retirement account. Employers may make matching contributions up to a certain amount.
DC plans invest with pre-tax contributions. Thus, withdrawing money before 59 ½ years old will be subject to early withdrawal penalties with some exceptions. All distributions will be taxed as ordinary income. As DC you know what you put in but you won't know what you may get when you retire due to market fluctuations.
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Traditional 401(k)
With a traditional 401(k), you fund your account with pre-tax dollars. Because your contributions are withdrawn from your paycheck before you’ve paid any taxes, your taxable income will be lower. For example, if you earned $70,000 in 2023 and you contributed $5,000 towards your 401(k), your taxable income will be reduced to $65,000.
However, when you withdraw from your account in retirement, your contributions and investment earnings are generally fully taxable. The taxes will be determined by the tax rate at the time of your withdrawal.
403(b)
A 403(b) plan (tax-sheltered annuity plan or TSA) is a retirement plan offered by public schools and certain charities. It's similar to a 401(k) plan maintained by a for-profit entity. Just as with a 401(k) plan, a 403(b) plan lets employees defer some of their salary into individual accounts. The deferred salary is generally not subject to federal or state income tax until it's distributed. However, a 403(b) plan may also offer designated Roth accounts. Salary contributed to a Roth account is taxed currently but is tax-free (including earnings) when distributed. Eligible employers are public school, college, or university, church, or charitable entity tax-exempt under Section 501(c)(3) of the Internal Revenue Code.
Roth 401(k)
With a Roth 401(k), you make contributions with after-tax dollars. This means that once you retire at age 59 ½ or later and begin taking distributions from your account, you won’t have to pay taxes on any of your contributions or earnings (not including any employer match, which will get taxed when you collect any of it). Whether you choose between investing in a traditional or Roth 401(k) depends on your preference and what your employer offers. If your company offers 401(k) plans to its employees, you may be able to invest in both or only one. Contact your plan administrator for more information.
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Many employees are passive participants. According to an AAPP survey, 71% of people with 401ks didn't know they were paying fees for their retirement accounts. Without understanding the different investment options of the plan, they may pick the one that doesn't meet their risk tolerance and objectives.
Get in touch with us to learn more.