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Types of Plans - Overview
In general, plans are either categorized as defined benefit plans or defined contribution plans.
Defined Benefit Plans provide for a specific benefit upon retirement based on a stated formula (usually based on a percentage of pay and years of service). These plans are fully funded by the employer and the employer bears all investment risk. Traditional defined benefit plans have been steadily declining over the last 20 years; however, cash balance plans have been steadily increasing in popularity.
Cash balance plans (also known as “hybrid” plans) are a special type of defined benefit plan that allows for greater deferral opportunities than under a defined contribution plan. They typically work in concert with a 401(k) profit sharing plan and are often used to maximize tax-deferred savings for owners, partners and other targeted key individuals. Cash balance plans have certain features similar to those found in defined contribution plans that make them much easier for participants to understand than benefits provided under a traditional defined benefit plan.
Defined Contribution Plans do not provide for a specific benefit upon retirement. Rather, participants or the employer (or both) make contributions to the plan. Upon retirement (or termination), participants are entitled to receive their vested account balance which includes accumulated contributions and related investment earnings (or losses). There are many types of defined contribution plans including 401(k), 403(b), profit sharing, money purchase pension, and employee stock ownership plans (ESOPs). Defined contribution plans can include a variety of features and offer great design flexibility. 401(k) plans are by far the most popular and provide plan sponsors with many options for determining participant eligibility, plan contributions and other design features. Common provisions in 401(k) plans include Roth contributions, automatic enrollment, safe harbor contributions, and cross-tested profit sharing contributions.