Defined Contribution Plans

The type of defined contribution plan you have may depend on where you work, but it is most likely one listed below.

• 401(k) plans are offered by private companies. Some nonprofit and governmental employers and unions offer this type of plan too.
• Money purchase plans are offered by private companies and by unions.
• 403(b) plans are offered to those who work for public schools and many other nonprofit organizations.
• 457 plans are for state and municipal employees, as well as employees of certain nonprofits.

If you have worked for more than one employer, you may have more than one type of plan. All of these plans are called "defined contribution plans" because you and/or your employer contribute to the plan. Some employers refer to these plans simply as “retirement savings plans.”

No. No law requires an employer to give workers a defined contribution plan—or any other retirement plan for that matter. However, some employers are required by a collective bargaining agreement with a union to contribute to a plan for their union workers.

There are several good reasons for having a defined contribution plan.

• You can have money regularly deducted from your pay, making it easier to save more.
• You can postpone paying taxes on some or all of the money in your account.
• You’ll probably be allowed to make choices as to how your money is invested.
• You’ll be able to take most (if not all) of the money saved with you when you change jobs.
• Many employers help workers save for retirement by putting money in these accounts for them.

How you save taxes will depend on the type of plan you have.

• With a traditional defined contribution plan, you don’t have to pay income tax upfront on the money you and/or your employer put into your retirement savings account. Interest or other investment returns on the money add up tax-free. You postpone paying taxes until you start taking money out of your account, and only pay income tax on the amount you take out.
• With a Roth plan, you have to pay income tax on any money you contribute from your paycheck to the plan. However, the money in your account grows tax-free and you don’t have to pay tax on your money when you withdraw it.

People who think they’re going to have a higher tax rate later (when they’re ready to withdraw their money) may prefer a Roth account so they pay their taxes upfront.

With a defined contribution plan, you and/or your employer put money into an account set up just for you. The amount put into the account, how the money is invested and fees paid determine how much you’ll have when you retire. With many defined contribution plans, you’re responsible for deciding how much you’ll put into your plan and how it will be invested.

In contrast, defined benefit plans promise you regular payments for life based on factors such your age, pay and years of service. Plan officials are responsible for making sure you receive what you’re promised. You don’t have to worry about whether this money will run out or how it is invested. The people overseeing your plan do this for you.

It depends. Some plans require you to reach a certain age (such as 21) or to work a certain amount of time (such as three months) before you and/or your employer start putting money in your account. Check your plan booklet (called a summary plan description or SPD) or ask your benefits/HR department or fund office about your plan’s eligibility requirements.

Vesting is a schedule that spells out when you’re entitled to all of the money in your retirement account. Any money you contribute from your paycheck is always yours. You may not, however, have the immediate right to contributions made by your employer. Federal law generally lets your employer postpone (up to 6 years) your rights to the money they put into your account. Some plans make you 100% vested (fully entitled to all money) after you’ve worked for the employer for 3 years. Other plans use a graduated vesting schedule so you earn rights to an increasing portion of your employer’s money over a 6-year period. Some plans have faster vesting schedules—even giving you full rights to employer money right away (this is called immediate vesting). Check your plan booklet or ask your benefits/HR department or fund office about your plan’s vesting requirements.

It costs money to keep track of the money in your retirement account, to process loans, to manage your investments and so forth. The fees and other charges you pay cover these costs. Federal law requires your plan sponsor to monitor these expenses—making sure the charges are reasonable for the services you receive. If your plan allows you to choose where the money in your account is invested, your employer or union must consider fees when deciding which investment options to offer you. They must also give you information about these fees to help you make your investment decisions.

A good place to start is your retirement plan booklet, called the summary plan description (SPD). You’ll receive this automatically from your plan, either by mail or electronically. If the SPD doesn’t have the information you need, ask your benefits/HR department or fund office for a copy of the more detailed plan document.

Ask your benefits/HR department or fund office whether they have a worksheet or other tools that can help you decide how much money you’ll need and how much you should save to reach your retirement goals. Here are worksheets to get you started.

Important things to consider are:

• Your health before and after retirement
• When you want to retire
• Whether you and your spouse/partner will have Social Security benefits, a pension, or other retirement income such as rent from property you own
• Whether you plan to work full- or part-time after retirement
• Whether you have a spouse, a child or others who will depend on your retirement income
• Where you want to live after retirement
• What you want to do after retirement
• How long your retirement might last.

How much money you think you’ll spend when you retire, how early you start saving, investment returns, and whether you’ll have other sources of retirement income are just some of the things that can make a big difference in how much you must save for retirement.

• If you’re in your early 20s, a good rule of thumb is to save 10% to 15% of your income.
• If you’ve delayed saving for retirement, you’ll probably have to save more. This chart estimates how much you’ll have to save each year to replace different percentages of your income after age 65. The numbers assume a generous 5% pay increase and a return on your savings of 7% each year. Recently, inflation has ranged from 0-9%. 
  

  ​Age When You Start Saving	​Percentage of Pay You Need to Save for a Percentage of Your Current Income in Retirement
  	​70%	80%	​90%	​100%
  ​25	9.4%	10.7%	​12.1%	​13.4%
  ​35	​13.3%	15.2%	​17.1%	​19.0%
  ​45	​20.4%	​23.3%	​26.2%	​29.1%
  ​55	​39.6%	​45.3%	​50.9%	​56.6%

• If you think there will be years when you won’t be paid because you’re raising children or caring for a parent, you may want to save an extra 5% or 10% of your income each year you work.
• If you’re a woman, you may want to save a little bit more. Women tend to live longer than men; this means your money may have to last longer in retirement.

It’s best if you start saving for retirement as soon as possible—your early 20s is ideal. If you start saving early, the “magic of compounding” makes it possible for you to start small and grow. The money you put into a retirement account earns interest and dividends that increase the amount of money in your account. As the money in your account grows, you earn money on an even bigger pool of money. Here are two examples of how compounding and saving early could affect what you put aside for your retirement.

• For every six years you wait before getting started, you’ll have to roughly double the amount you save each year.
• To get the same amount of money at retirement, you can contribute $2,000 each year for the next nine years OR wait nine years and contribute $2,000 for the next 41 years!

When a worker puts money into their retirement account, some employers “match” the contribution by also putting money into the worker’s account. The amount of the match varies from employer to employer. It might be 25 cents, 50 cents or even one dollar for every dollar the employee pays in, up to a certain percent of the worker’s salary. These matching contributions can dramatically increase your savings, so be sure to take advantage of them if they’re available to you. If you don’t, you’re leaving “free” money on the table.

Because of the valuable tax breaks, it makes sense to put the maximum amount in your account each year. If that isn’t possible, try to contribute at least enough to get any matching contributions from your employer. Your plan booklet or benefits/HR/fund office staff can tell you how much you must contribute to get this “free” money.

When you file your taxes, be sure to check whether you can also get the federal government’s Saver’s Tax Credit which can help you put money in a retirement savings account and reduce your federal income taxes.

To encourage people to save for retirement, the federal government offers the Retirement Savings Contribution Credit, sometimes referred to as the Saver’s Credit. With this credit, you may only have to save between $500 and $900 to put $1,000 into a retirement savings account. If you’re married, just $1,000 to $1,800 may make it possible to put $2,000 in your account.

The size of your credit depends on how much you can save, your income and your filing status. You calculate and claim this credit when you do your annual federal income taxes. You’re eligible for this credit if you:

• Are not a full-time student
• Can’t be claimed as a dependent on another person’s tax return AND
• Have an adjusted gross income on your federal income tax form that is under limits set by the federal government. 

This is a way for you to "catch-up" on your retirement savings if you think you'll need more than what you've already saved. If you're 50 years or older, the federal government lets you save an extra amount annually beyond the normal limit set for you. Consult the Internal Revenue Service web pages for the current amount.

No. You don’t have to put money into a defined contribution plan, but it’s a good idea to do so if your employer or union offers one. Did you know you could actually lose money if you don’t make contributions?

• Depending on the type of plan you have, the money you put into your retirement account will reduce your taxes either in the year you contribute or when you decide to take your money out of your account.
• As long as your money stays in the plan, you won't pay a penny in tax on any interest or other investment returns. This means your money will grow faster than if you had to use some of your earnings each year to pay taxes.
• Some employers add money to their workers’ accounts, whether or not workers set aside their own money. Other employers add their own money only when workers save as well. If your employer provides a matching contribution based on the money you set aside, you won’t get that extra money unless you contribute to your plan.

Yes. You always have the right to change your mind whether you’ll put money in your plan and how much. Since the rules for making changes can vary from plan to plan, ask your benefits/HR department or fund office what you need to do to make changes.

Often, employers contribute to a retirement plan to attract and retain good workers. Also, many employers think helping workers achieve a secure retirement is the right thing to do. If you’re in a union, your employer probably negotiated your benefits with your union. To encourage contributions to a retirement plan, the federal government offers tax breaks to your employer.

Contribution decisions depend on who sponsors your plan. If your plan is set up by one employer—a single employer plan—these decisions are made by (1) the employer or (2) negotiation between the employer and a union.

If you have a multiemployer plan that permits many employers in the same trade or industry to contribute to the same retirement plan for their workers, a collective bargaining agreement and other legal documents state how much your employer must contribute to the plan, if anything.

Depending on the type of plan, the federal government also has rules on what can or must be contributed by employers.

How much money you’ll get from your plan depends on how much money was contributed to your account, how well the money was invested and the fees charged.

In most situations, any money that you’ve put into your individual account is your money and you can take it out at any time. If and when you can take out money put into your account by your employer depends on the rules of your plan, and when you become vested.

BEWARE! While you may be able to get your money, you’ll have to pay a 10% penalty to the federal government if you do so before reaching age 59½. You’ll also have to pay federal income tax on money you withdraw—how much depends on whether your plan is a traditional or Roth plan. (Note: state tax rules vary.)

• With a traditional plan, you’ll have to pay federal income taxes on every dollar that you take out of your account.
• With a Roth account, if you withdraw money before reaching age 59½, you only have to pay federal income tax on the earnings in your plan. Remember, you’ve already paid taxes on this money when you first contributed it to the Roth account. If you withdraw money after reaching age 59½, everything you take out is tax-free.

Your plan’s rules determine whether you can borrow money, how often you can borrow and whether you can have more than one loan at a time. You’ll need to pay interest on the amount you borrow.

Not all plans allow loans. When a plan does allow workers to borrow money, the IRS limits the amount to no more than 50% of your vested account balance or $50,000, whichever is less. An exception to this limit is if 50% of the vested account balance is less than $10,000. In this case, you could borrow up to $10,000. However, your employer's plan may not include this exception.

Generally, the IRS requires you to repay your plan loan within 5 years, and make payments at least quarterly, but there are some exceptions. For example, you can request a loan extension if you’re using the money to buy a home that will be your primary residence.

Caution: If you don’t pay your loan back on time :

• You’ll reduce your retirement benefits because you can’t make up for what you borrowed through larger plan contributions later.
• You’ll have to pay income taxes on the amount you borrowed.
• You’ll have to pay a 10% penalty to the IRS if you’re younger than age 59½.

Before you borrow any money from your plan, ask your benefits/HR department or fund office:

• What would happen if you’re laid off or change jobs? (Some plans make you pay back your loan immediately.)
• Is it possible to get a loan extension if you have to take a leave of absence from your job or you’re called to active military duty?

With most defined contribution plans, you decide how you’ll withdraw and use the money in your account. Some plan sponsors will let you set up a payment schedule for the withdrawal of your money or give you the option of using some (or all) of your money to purchase an annuity. An annuity is an insurance contract you can buy with your savings that guarantees you a steady income for a set amount of time or the rest of your life. Some annuities will provide an income for the rest of both your and your partner’s life.

For some plans, federal law requires that you start withdrawing money from your plan by April 1 of the year after the calendar year you turn age 73. It doesn't matter whether you've retired. For others, such as 401(k) and 403(b) plans, you can put off taking money out until April 1 following the year you retire. By delaying when you start your withdrawals, you'll have more money in your account because of additional earnings. Note: In 2033, the Required Minimum Distribution age will increase to age 75.

If you have to pay taxes, you pay them as you withdraw the money from your account. How much you pay depends on the type of plan you have and where you live.

• Traditional plan. With these plans, any money you withdraw will be taxed as federal personal income.
• Roth plan. Since you paid income tax on your money before you put it into your retirement account, you don’t have to pay federal income tax on it when you take it out. If you wait until age 59½ or later, you also don’t pay federal income tax on money earned in interest or investment returns.

In addition, regardless of the type of plan you have, you don’t have to pay Social Security payroll tax.

When it comes to state taxes, the rules vary. Most states tax retirement income from a traditional plan the same as any other income you receive. Like the federal government, however, they don’t tax interest or investment earnings from a Roth plan. A few states don’t tax individual income—retirement or otherwise. There are also a few states that exempt some or all retirement income from state income tax.

Some defined contribution plans are sponsored by a union/labor organization with many employers contributing to the same plan (this is called a multiemployer plan). If you remain with the same employer but transfer to a job not covered by the labor plan, your employer must give you vesting credit for the time you work even though your employer won’t be contributing to the plan on your behalf. If you get a job with another employer that contributes to the same multiemployer plan, you will continue earning benefits the same as if you were with your original employer. If you get a job on a project in another city or region, working for an employer that doesn’t contribute to your plan but instead to a different plan, you may be able to continue earning benefits in your original plan under a reciprocity agreement.

Have you worked instead for an employer with its own plan (a single-employer plan)? If you change jobs, you get to keep any money you’ve put into your defined contribution plan. Whether you get to keep any money your employer contributed into your account depends on whether you’re vested.

• If you’re fully vested, the employer’s money is yours.
• If you aren’t fully vested, you give up (forfeit) the portion of your employer’s money that was not vested. When you change jobs, you must also decide what to do with the amount saved in your account.
• Leave it where it is. Even though you’re no longer receiving money from your old employer, you may be able to keep your account with their plan, making use of their system and investment choices.
• Roll it over. With this option, you ask your old plan to transfer (roll over) your money to another retirement account. Some defined contribution plans allow rollovers by new employees. Check with your new benefits/HR department or fund office to see if you can transfer money into their plan. You can also roll your money into an individual retirement account (IRA).
• Cash it out. This is usually a bad idea because:
  • If the money you withdraw had been in a traditional pretax defined contribution account, you’ll have to pay income tax on the amount you withdraw.
  • If you’re not yet age 59½, you’ll also be hit with a federal 10% early withdrawal penalty on the amount you withdraw.
  • If you use the money to pay a bill or buy a new car, for example, you’ve lost that money’s growth potential for use in retirement.
  • Your money will no longer have the tax advantages of a defined contribution plan.

Time provided under the federal Family and Medical Leave Act (FMLA) can’t be considered a “break” in your service. That means you’ll vest in the same amount of time as if you hadn’t taken the leave.

State law governs how the property owned by you and your spouse is divided—this includes the division of your retirement savings. If you and your spouse can’t agree on how to divide your retirement benefits, a state court will decide for you. The court may award some or all of your retirement benefits to you, your current spouse, a former spouse, children or other dependents.

Once a court makes a decision dividing your marital property, it issues a domestic relations order regarding the distribution of your retirement benefits. You need to give a copy of this order to your benefits/HR department or fund office. If the order complies with federal law, the payments are made as directed by the plan and the court. If the order does not comply with federal law or the terms of your plan document, the order will need to be revised.

If you’d like to stop contributing to the plan, ask your benefits/HR department or fund office what you need to do to make changes. If you owe money to people or businesses, your retirement benefits are generally safe from their claims. However, the IRS or your state department of revenue may place claims on your benefits for unpaid taxes.

If you become disabled and aren’t able to work, you may be able to take money out of your account without a federal penalty. You may also be able to roll it over into another account, like an IRA. Check with your benefits/HR department or fund office to find out what your plan allows.

At your death, a plan will typically consider you to be fully vested and all the money in your account will be available to your beneficiaries, trust or estate. There are different rules as to how quickly your money will be handed out, depending on whom you’ve named as your beneficiary. It can be within 1 year, 5 years, 10 years, or the year when you would’ve turned age 72. Ask your benefits/HR department or fund office to explain your plan’s rules.