Employer-Sponsored Retirement Plans (Defined Benefit and Defined Contribution)
Defined benefit plans
A DB plan promises a benefit, typically a formula such as years of service times an accrual rate times final average pay. Thirty years at 1.5% of $80,000 final average pay produces $36,000 per year. The employer bears the investment risk. Vesting is limited by statute to a 3-year cliff or 2-to-6-year graded schedule for employer-derived benefits. The PBGC insures most private single-employer plans up to statutory limits. Cash balance plans are DB plans expressed as a hypothetical account and often pay a lump sum at retirement.
Defined contribution plans
401(k), 403(b), governmental 457(b), and profit-sharing plans promise only the account balance. Key mechanics: elective deferral limits with age-50 catch-ups (and an enhanced catch-up for ages 60 to 63), employer match and vesting schedules, nondiscrimination testing, top-heavy rules, loans, and hardship withdrawals.
Traps
- Applying the 10% early-withdrawal penalty to a governmental 457(b) distribution before age 59 and a half. The penalty does not apply to governmental 457(b) plans.
- Assuming a match is free money regardless of the vesting schedule.
- Confusing a DB accrual rate with a DC contribution rate.
- Forgetting that Roth 401(k) balances are no longer subject to lifetime required minimum distributions.
- Forgetting that employee elective deferrals are always 100% vested.
Worked example
An employer matches 50% of the first 6% of pay. A participant earning $80,000 who defers 6% contributes $4,800 and receives $2,400 from the employer. That is an immediate 50% return on the matched dollars before any investment growth, which is why capturing the full match is the first funding priority in any employer plan.