When it comes to retirement plans, you could have a defined contribution or a defined benefit plan. If you have a 401k plan offer from your employer, this is not known as a defined benefit plan. Instead, you are actually using a defined contribution plan in which you and your employer put money into it.
Defined Benefit Plan
A defined benefit plan is a type of retirement plan that is offered by employers as a benefit to employees. This type of plan guarantees a specific retirement benefit for employees after a certain number of years of service. This plan is also referred to as a pension plan. With this plan, you have a level of certainty in your retirement because it is essentially guaranteed by the company.
Defined Contribution Plan
The defined contribution plan is another type of retirement option that you may have access to. Many employers now offer this type of retirement plan instead of the defined contribution plan. With this type of plan, the employee makes contributions to the plan for their own retirement. The employer also has the ability to contribute to their employees' accounts. These employer contributions help the employer with a tax deduction and they help the employee with extra money for retirement.
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The 401k is a type of defined contribution plan that can be used by employees and by self-employed workers. With this type of plan, you have the ability to contribute up to $16,500 per year out of your annual income as of 2010. This number increases to $22,000 per year once you reach the age of 50. The contributions that you make to the 401k are on a pretax basis. Then the money that you earn from investments in the 401k is not taxed until you start taking money out at the age of 59 1/2.
One of the benefits of the 401k is that you have control over what you put your money into. With the defined benefit plan, you do not have any control over which investments are chosen for your money. With the 401k, you can choose between stocks, bonds, mutual funds and other securities. Another benefit of this type of plan is that you could potentially increase your retirement benefits even more than what they could be through a pension. If your investments perform very well, you could have a much more comfortable retirement.
One of the drawbacks of the 401k is that it is not guaranteed like a defined benefit plan is. With defined benefit plans, the company guarantees a certain amount of retirement benefit. Even if the company goes out of business, the pension is still guaranteed by the Pension Benefit Guaranty Corporation. This is a government-sponsored enterprise that guarantees pension benefits. Another advantage of defined benefit plans is that the benefits can be substantial even if you only work for a company for a short time.