Glossary: Types of Retirement Plans
401(k) Plan: This is a retirement plan where an employee defers part of his or her current income into a tax shelter where it grows tax-free until the employee withdraws it. The employer has the discretion to match the employee's contributions. Annual contributions of employer and employee are limited to 25 percent of salary or $30,000. The plan allows an employee to save for retirement and simultaneously reduce his or her current income tax bill. Employees are often allowed to make decisions as to the investment of these funds.
Defined Benefit Pension Plan: This is a traditional pension plan that pays workers a specific monthly benefit at retirement. These plans either state the promised benefit as an exact dollar amount or specify a formula for calculating the benefit. Generally, a company funds the pension plan, and a professional money manager invests the assets of the fund.
Individual Retirement Account (Traditional): This is not a qualified retirement plan; it is described under a different section of the Tax Code. An IRA is established by an individual, not a company. Under this plan, an individual can deposit up to $2,000 of earned income a year into an IRA. If an individual is not eligible to participate in a pension, profit sharing, or 401(k) plan at work, the contributions to the IRA are deductible irrespective of the person's income. If the individual is covered by a company retirement plan, he or she loses his or her right to the IRA deduction as his or her adjusted gross income exceeds certain levels. Traditional IRA earnings are taxed when they are withdrawn.
Keogh Plan: This is a qualified retirement plan for self-employed individuals. Contributions to this plan are tax-deductible. The individual can direct the investment of the funds that are put into a Keogh, e.g., stocks, bonds, or mutual funds.
Qualified Retirement Plan: A qualified plan is one that is described in Section 401(a) of the Tax Code. A qualified retirement plan is established by a business. The most common types of plans are profit sharing plans, defined benefit plans, and money purchase pension plans. Your contributions to a qualified plan are not taxed until you withdraw the money. In addition, any contributions made to the plan on your behalf by your employer are tax deductible.
Roth Individual Retirement Account: This is similar to the traditional IRA except the contributions to a Roth IRA are nondeductible. When you withdraw money from a Roth IRA in retirement, it will be tax-free.