Retirement Plans 101

Employer-sponsored retirement plans fall into two broad categories: defined contribution plans and defined benefit plans. Defined contribution plans, the more prevalent type today, include 401(k) plans for private sector employers, 403(b) plans for nonprofits and educational institutions, 457(b) plans for state and local government employees, and SIMPLE IRA and SEP IRA plans commonly used by small businesses. In these plans, employees and employers contribute to individual accounts, and the retirement benefit depends on contributions made and investment performance over time. Defined benefit plans — traditional pensions — promise employees a specified monthly benefit at retirement, calculated based on salary history and years of service. The employer bears the investment risk in a defined benefit plan. Many employers have shifted from defined benefit to defined contribution plans over recent decades due to cost and administrative complexity. Each plan type has distinct IRS contribution limits, vesting schedules, and compliance requirements that plan sponsors must understand to administer effectively.

The 401(k) and 403(b) are both defined contribution retirement savings plans with similar structures, but they are designed for different types of employers. A 401(k) is available to employees of private, for-profit businesses. A 403(b) is available to employees of public schools, colleges and universities, hospitals, and qualifying nonprofit organizations under IRC Section 501(c)(3). Both plans allow employees to make pre-tax (traditional) or after-tax (Roth) contributions up to the same annual IRS limit, with catch-up contributions available to employees age 50 and older. Employers can offer matching contributions under both plan types. Historically, 403(b) plans had somewhat fewer administrative requirements than 401(k) plans, but regulatory changes have narrowed this distinction over time. One notable feature of 403(b) plans is the special 15-year catch-up contribution provision available to employees with 15 or more years of service with a qualifying organization. Both plan types are subject to ERISA and IRS compliance requirements.

The IRS sets annual contribution limits for employer-sponsored retirement plans, which are adjusted periodically for inflation. For 401(k), 403(b), and most 457 plans, the employee elective deferral limit for 2025 is $23,500, with an additional $7,500 catch-up contribution allowed for employees age 50 and older. The SECURE 2.0 Act introduced a higher catch-up contribution limit of $11,250 for participants aged 60 to 63 beginning in 2025. The overall annual additions limit — combining employee and employer contributions — is $70,000 for 2025. For SIMPLE IRA plans, the employee contribution limit is $16,500 with a $3,500 catch-up for those 50 and older. SEP IRA contributions are employer-only, limited to the lesser of 25% of compensation or $70,000. Plan sponsors must monitor these limits carefully to avoid costly excess contribution corrections and IRS penalties. Staying current on annual IRS inflation adjustments is an essential part of retirement plan administration and employee communication.

Retirement plan sponsors owe fiduciary duties to plan participants under ERISA — the Employee Retirement Income Security Act — and breaching those duties can result in personal liability, plan corrections, and Department of Labor enforcement actions. Core fiduciary responsibilities include acting solely in the interest of plan participants and beneficiaries, following the plan document, diversifying plan investments to minimize the risk of large losses, paying only reasonable plan expenses, and following the prudent expert standard in all plan decisions. Plan sponsors must select and monitor investment options prudently, review plan fees regularly to ensure they are reasonable relative to services provided, and ensure plan documents remain current and compliant. They must also adhere to required participant disclosure timelines — including plan documents, fee disclosures, and investment information. Many employers address fiduciary risk by establishing an investment committee with a documented governance charter, retaining an ERISA fiduciary advisor, and conducting annual plan reviews. Fiduciary education for committee members is essential to ensure all decision-makers understand their obligations.

Defined benefit and defined contribution plans represent fundamentally different approaches to employer-sponsored retirement savings. In a defined benefit plan — a traditional pension — the employer promises a specific monthly retirement benefit, typically calculated using a formula based on years of service and final or average salary. The employer bears full investment risk and is responsible for funding the plan to meet future benefit obligations, which may require actuarial assessments and variable employer contributions. In a defined contribution plan, such as a 401(k) or 403(b), there is no promised benefit amount; instead, the employee and often the employer contribute to an individual account, and the retirement income depends entirely on contributions made and the investment returns earned over time. The investment risk is borne by the employee. Defined contribution plans are more portable — employees typically take their vested account balance when they leave — while defined benefit plans may have longer vesting periods and reduced benefits for early leavers. Most new retirement plans established today are defined contribution due to lower employer cost volatility and administrative complexity.