Getting ready for retirement doesn't happen all at once. It takes small steps to create a comfortable and secure plan that aligns with the type of life you want to live after leaving the workforce. A great place to start is exploring the defined contribution plan offered through your employer.
Defined contribution plans are a popular way to save for retirement due to their relative simplicity and potential tax advantages. However, depending on the types of defined contribution plans offered at your workplace, you may decide to choose a combination of choices rather than focus on one.
How do defined contribution plans work?
A defined contribution plan is a retirement account offered through an employer. They include:
You and your employer can both contribute funds into this account up to certain limits set by the IRS each year. Once you contribute to these accounts, you can invest your money in any of the provided
One major differentiator between a defined contribution plan and a non-401(k) investment account, such as a
- Traditional defined contribution accounts are often "tax later" since they only require you to pay income tax when withdrawing money in retirement.
- Roth-style defined contribution plans (such as a
Roth 401(k) ,Roth 403(b) , andRoth 457(b) ) have both "tax now" and "tax never" features. Since taxes have already been paid on Roth contributions when they were made, there will be no additional tax liability when you take distributions in retirement. Additionally, your earnings will be tax-free if you make a qualified distribution.1
2023 & 2024 defined contribution plan limits
The IRS sets annual contribution limits for account holders of defined contribution plans. Additionally, people 50 and older can contribute even more through a
Types of defined contribution plans | 2023 contribution limit | 2024 contribution limit |
401(k), 403(b), most 457 plans, and government Thrift Savings Plan (TSP) | $22,500 per individual | $23,000 per individual |
If age 50 or over (same set of plans) | An additional $7,500, for a total of $30,000 | An additional $7,500, for a total of $30,500 |
How do defined contribution plans differ from defined benefit plans?
Defined contribution plans, by contrast, are widely available to working adults. They don't guarantee a particular amount of income in retirement and can change in value based on the performance of your investments. A major advantage of defined contribution plans is their portability; unlike with some defined benefit plans, assets can roll over to a traditional IRA or your new company's 401(k) plan
There are benefits and drawbacks to both kinds of plans, but defined contribution plans have grown in popularity with employers over the defined benefit plan or pension model. Ultimately, participation is dependent on what your employer offers.
Making the most of a defined contribution plan
Consider these four strategies to optimize your retirement savings:
1. Aim for the employer match
At many companies, the
2. Keep tax-efficiency top of mind
Traditional 401(k) tax advantages arrive early, when you first earn and contribute the money. This is most advantageous if you expect to earn a higher income now than you will later on. Meanwhile, Roth 401(k) tax advantages arrive in retirement. If you're earning a lower income now but expect your income to grow over time, paying the taxes now through a Roth 401(k) account could mean paying less overall, with no tax liability in retirement on those withdrawals.
One strategy for
3. Boost your savings by also using IRAs
If you don't have a defined contribution plan, you can use an
Additional things to note:
Traditional IRA contributions may be deductible on your tax return.3Roth IRAs have income limits to participate.4
2023 & 2024 IRA contribution limits
IRA types | 2023 contribution limit | 2024 contribution limit |
Roth IRA and Traditional IRA | $6,500 per individual | $7,000 per individual |
If age 50 or over (same IRA plans) | An additional $1,000 for a total of $7,500 | An additional $1,000 for a total of $8,000 |
4. Pay yourself first to automate good saving habits
When you first start a new job or role at your company, your defined contribution plan represents a powerful opportunity. You can choose a dollar amount or a set percentage—anywhere from 1% to 10% or more—to subtract from your paycheck and contribute toward your defined contribution plan. You won't see those funds for years, so saving in this way may mean you never miss the money in the first place. The
Of course, if you do have a major change in circumstances, you can always reduce that automatic contribution by working with your HR department or plan administrator. You're not locked in forever. With busy lives full of decisions, many of us value the opportunity to make a wise choice like this one time and reap the benefits for years to come.
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3 potential disadvantages of defined contribution plans
All forms of retirement savings have benefits and drawbacks. Knowing the structure of defined contribution plans can help you prepare ahead of time and minimize pitfalls.
1. Vesting
Some employer contributions aren't
2. Fees may vary
While IRAs often have many investment options, some defined contribution plans only have a few choices available. These funds may have substantial management fees, which can eat into the returns you gain from your investments. Reviewing the fees on both IRA and defined contribution plan options helps you make informed decisions.
3. Retirement income is not guaranteed
Defined contribution plans do not guarantee you a given monthly or annual payout each year of retirement. You'll need to manage your account's level of risk, especially as your retirement date approaches.
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