Types of Plans
There are a wide array of business retirement plan options that qualify for preferential tax treatment under the federal tax code. While there are subtle variations in the type of preferential tax treatment afforded different types of plans, what we’re generally looking at is some combination of tax-deductible contributions, tax-deferred growth, and (in the case of Roth contributions), potential tax-free withdrawals. In order to help you set up your plan, there are tax credits that cover plan startup costs.
There are two broad categories that retirement plans fall into, the defined benefit plan--think pensions--and the defined contribution plan--think 401(k). These are fundamentally different approaches to retirement planning for businesses. Here are the details:
Defined Contribution Plans
Although defined benefit plans such as pensions have formed the backbone of the U.S. employer-sponsored retirement plan system for many decades, they have been on the decline in recent years as more and more employers shift to defined contribution plans. With a defined contribution plan, such as a 401(k), there is not typically any guarantee of what participants will have at the time of retirement (i.e., the employee, and not the employer, bears the investment risk). Here are some other attributes of a defined contribution plan:
- Often funded by both employer and employees
- Benefit at retirement is not guaranteed
- Employee bears investment risk
- There are two main types of defined contribution plans:
Defined Benefit Plans
Although defined benefit plans such as pensions have formed the backbone of the U.S. employer-sponsored retirement plan system for many decades, they have been on the decline in recent years as more and more employers shift to defined contribution plans. Here are some attributes of a defined benefits plan:
- Historically prevalent, primarily employer-funded
- Benefit at retirement is guaranteed
- Employer bears risk
- Example: Pension plans
The plans discussed here are defined contribution plans, the most common types of plans in the small business market.