DEFINED BENEFIT PROGRAMS
A defined-benefit plan is an employer-sponsored retirement plan where employee benefits are computed using a formula that considers several factors, such as length of employment and salary history. The company administers portfolio management and investment risk for the plan. There are also restrictions on when and by what method an employee can withdraw funds without penalties.
Defined-benefit plans are termed "defined" because individuals, employees, and employers know the formula for calculating retirement benefits ahead of time. Since the contributor is responsible for making investment decisions and managing the plan's investments, the contributor will assume all the investment risk. A tax-qualified benefit plan has the same characteristics as a pension plan, but it also gives the employer and beneficiaries additional tax incentives not available under non-qualified plans.
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A defined-contribution plan is retirement plan that's typically tax-deferred, like a 401(k) or a 403(b), in which employees contribute a fixed amount or a percentage of their paychecks in an account that is intended to fund their retirements. The sponsor company will generally match a portion of employee contributions as an added benefit to help retain and attract top talent. These plans place restrictions that control when and how each employee can withdraw from these accounts without penalties.
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INDIVIDUAL RETIREMENT ACCOUNTS (IRAS)
What they are: Tax-advantaged savings accounts for individuals.
Pros: Tax benefits; investments grow tax-deferred and contributions may be deductible; numerous investment choices with range of risk/reward characteristics.
Cons: Early withdrawal penalties (plus income tax); annual contribution limits; some eligibility restrictions.
How to invest: Directly through financial institutions – banks, mutual fund companies and brokerage firms.
Tip: Start early and save as much as you can to take advantage of the power of compounding.
Think of an individual retirement account (IRA) as a savings account with tax advantages, plus the benefits of compounding. You open an IRA for just yourself (thus the individual in the name), so spouses have to open separate accounts. It’s important to note that an IRA is not an investment itself; instead, it’s an account where you keep investments – such as stocks, bonds and mutual funds. You choose the investments in the account and switch them around as you please. There are several types of IRAs, including traditional, Roth, SEP and SIMPLE. In many cases, you can have more than one type of IRA as long as you meet certain requirements.
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