Understanding Contributions vs. Benefits
If you have a defined contribution plan, you’re going to know a lot more about how much goes into your account than what will ultimately come out. Your contribution is defined (usually as a percentage of salary), but not the ultimate benefit. Your benefit at retirement will depend on the size of the contributions made by you and/or your employer and the future performance of the investments in your account.

Contributions to a defined contribution plan are typically made with pre-tax money. That means the contributions aren’t subject to income tax at the time they are paid into the plan. For example, if you contribute $3,000 of your $50,000 salary to a defined contribution plan, such as a 401(k) on a pre-tax basis, the $3,000 isn’t counted as salary for income tax purposes. You’d report $47,000, not $50,000, on your income tax return, reducing your taxable income.

Benefits of Tax Deductible Contributions
If your contributions are not taxed, you’ll have more money invested. When you contribute $3,000 to a plan, you’ll have the full amount working for you, not $3,000 less taxes.

Your contributions are typically sheltered as you put them in, and often taxed at a lower rate when you take them out. How can you expect to pay lower taxes? When you’re retired, you’re likely to be making less money and tax rates are generally lower on lower levels of earnings.

Even better, your contributions and earnings will be protected from income tax until you take the money out. You have more growth potential, since the entire amount stays invested, and untaxed, year in and year out.

Making Contributions Automatic
You can easily set up automatic payroll contributions to your defined contribution plan. Employers may match or make all the contributions..

Funding Alternatives
Most 401(k) plans allow employees to make contributions and provide for partial or full matching contributions by the employer. If your employer matches even half of your contributions, you get a 50% boost in the size of your retirement account.

Employee pre-taxable contributions cannot exceed $58,000 in the year 2021. The total of employee and employer contributions to a 401(k) plan has a limit equal to the lesser of 25% of compensation, or $58,000.

Under other types of defined contribution plans (e.g. profit sharing plans and money purchase pension plans), the employer makes contributions. Employee contributions may or may not be part of those plans.

Transferring Plans
Accounts under most defined contribution plans can be transferred to another qualified retirement plan or IRA. If you separate from a company, you’ll usually have the option to roll over your account.

Delaying Distributions
In some cases, you can delay your distributions beyond age 70½. That’s the age at which you must begin to take out your distributions, by law. If you choose to keep working, for instance, you may be able to continue the tax-deferred growth of your retirement account.

Retirement Plan Contributions vs. IRAs
As of 2021, IRA contributions are limited to $6,000 per year ($12,000 per year for married couples). A new law has recently passed that will soon raise these limits. Under defined contribution plans, the contribution limits can be much higher. Some limits apply to employee contributions; others to employer contributions; and some apply to the combined amount of employee plus employer contributions.

With traditional IRAs you may qualify to get an income tax deduction for your contribution. You make contributions to a Roth IRA with after-tax dollars, getting no deduction for the contributions. However, with the Roth IRA, you may receive distributions free of income tax.

Vesting
Your rights to benefits vest when they become non-forfeitable, when you own them. You are always 100% vested in employee contributions and any earnings on those contributions. Your vesting rights to employer contributions vary with the type of plan you’re in, as well as the plan provisions and the laws governing the plans.

The way you vest and the contributions you receive will vary with the type of plan you’re in, as well as with the plan provisions. You may be 100% vested immediately or it may take up to 7 years to be fully vested. Government plans may have different provisions.

Paying Income Tax on Distributions
Defined contribution plans are tax-deferred, not tax-free retirement plans. The growth of your investments is sheltered from income tax while your assets are in the retirement plan, but you’ll eventually have to pay income tax on the cash distributions you take out. (The exception? When you make a qualified rollover or qualified transfer to another plan).

The current federal income tax rates range from 15% to 40%. Retirement plan distributions are subject to these ordinary income tax rates unless special tax averaging applies.

Taking Responsibility for Your Financial Future
In many ways, defined contribution plans put additional responsibilities on employees. If you are an employee, your plans may be your only source of your retirement benefits. Making sound investment decisions will help that money grow.

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Charles M. Bloom, Registered Principal offers securities and advisory services through Centaurus Financial, Inc. - Member FINRA and SIPC - 775 Avenida Pequena, CA, 93111 (mailing address: 3905 State Street Suite 7173, Santa Barbara, CA, 93105) - CA Life Insurance License No. 0A52786 - Centaurus Financial, Inc. and Shoreline Wealth & Investment Management are not affiliated companies.

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