What is a 401k?
A 401k plan is an employer-sponsored retirement plan.
Odds are if you work at a for-profit company you will have a
401k plan made available for you to participate so you can
save for retirement. Each 401k plan has its own set of rules.
For example, some plans may require you to wait three
months before contributing, some plans will offer a great
match, some plans offer a Roth option and some plans might
even enroll you automatically when you start working.
401k's are voluntary accounts, meaning you only participate
if you want. You can also start and stop contributions at any time. The big benefits of the 401k plan are the tax benefits, the employer match and the convenience of payroll-deducted forced savings. The major drawbacks of the 401k plan are the access to your money and depending on your plan, the fees and investment options available inside of the plan. You need to be very aware of the fees charged in your specific plan. Watch the video above for more information about 401k plans.
What is a 403b Plan?
A 403b plan is a retirement plan used by non-profit
organizations, public school districts, certain religious
groups, certain hospitals, and government organizations.
It works very similarly to a 401k plan. For example, your
contributions are made pre-tax and are payroll deducted,
the funds grow tax-deferred during your working years
and then withdrawals are taxed as ordinary income in
retirement. A major difference is most 403b plans use an
annuity contract (Tax Shelter Annuity), which is provided
through an insurance company. A big problem with these annuity 403b accounts are the fees. Most people have no idea how much they are actually paying in these accounts because it is hidden very well. If you currently contribute to a 403b plan your homework assignment is to go figure out how much in actual dollars you paid in fees over the last year.
What is a 457 Plan?
A 457 plan is another type of employer-sponsored retirement plan offered to state and local government employees along with some non-profit organizations. It is also known as a deferred comp plan and has many similarities to a 401k plan.
One very nice feature if your employer offers both a 403b and a 457 plan is that you can contribute the maximum amount to both. So you could actually max out your 403b contributions and max out your 457 contributions allowing you to save double the amount in retirement plans than just a typical 401k participant can.
Another cool feature of 457 plans is that there is no 10% IRS penalty for early withdrawals once you separated from your employer. So if you retire at age 45 from the police department you can start taking withdrawals from your 457 plan without a penalty. You will always pay income tax on withdrawals similar to a 401k or 403b, but not 10% early withdrawal penalty.
What is a Defined Benefit Plan?
A defined benefit plan is a fancy term for a pension. It is a retirement plan that pays a specific amount each month in retirement based on a calculation using the employee's age, earnings and years of service at retirement. Some pensions will include a cost of living adjustment (COLA) so the payments increase with the cost of living through the years. A simple example is a teacher that works in the public school system for 30 years will get a pension or defined benefit of 60% (2% for each year) of their final average salary over the last 5 years. So if their final average salary is $100,000 then their pension will be for $60,000 per year for the rest of their lives.