|
| What’s So Great About DC Plans |
| Defined contribution (DC) plans may not offer a guaranteed benefit at retirement, but they offer plenty of benefits during the working years, including: |
|
| Accessibility |
| For employees, the appeal of DC plans begins with their “hands-on” accessibility. Unlike pension funds, in which employees’ money is pooled together and invested by the company, DC plans are administered on an individual basis, with a separate account for each employee. Consequently, you—not the company—decide how your retirement savings are invested, giving you much greater control over your money than in the pension system. |
|
| Portability |
| DC plans are also portable, meaning you can take the money with you. If you quit before retirement you can roll your funds over into an IRA, or in some cases, to your next employer’s DC plan. Even if you leave the money at your former company, your investments will remain active until you retire. With pensions, your benefit is typically frozen if you leave the company early. |
|
| Pretax Contributions |
| Perhaps the greatest benefit is the tax advantage DC Plans offer. Normally, when you invest in stocks, bonds, or mutual funds, you pay taxes on any interest or dividends you receive and on capital gains (profits you or your mutual fund realize from the sale of investments). On the other hand, DC plans allow your investments to grow tax-deferred. The IRS collects its due when the funds are withdrawn, but not before then. And since 2002, the government has been increasing the annual amount you can contribute to DC plans. |
|
| Some plans allow employees to deduct contributions from their paychecks before taxes are calculated. For someone in the 28% tax bracket, this means that a $100 contribution will result in only a $72 dollar reduction in take-home pay. |
|
| Employer Matching |
| Many employers offer to match employee contributions according to a certain formula—for example, a 100% match of the first 5% of employee contributions. This is one of the best investment deals going. Consider that a 100% match means that you double your money instantly. Generally, you earn the right to employer contributions over a period of one or more years—a process known as vesting. If you leave your job before you are totally vested, you’ll forfeit some or all of the employer’s contributions. But you are always fully vested in any contributions you make. |
|
| Things to Keep in Mind |
| With so many advantages to consider, it’s easy to overlook an important fact about DC plans: they are riskier than pension programs. There is no predetermined benefit with DC plans, so what you end up with at retirement depends on the performance of your investments. |
|
| Your long-term results, in turn, depend on your investment strategy—and here’s where another risk emerges. Specifically, some people invest their DC money only in bond funds, money markets, or other conservative investments, rather than shooting for the greater growth potential offered by stocks. The problem with the “safe” approach is that the investments likely won’t even keep up with inflation, resulting in a diminutive payoff come retirement. Alternatively, a too aggressive of a strategy, especially if you closing in on retirement, also can be detrimental if the market tanks. |
|
| Another risk is that an individual may choose not to participate at all. Some people opt out of the plan, either because they think retirement is still too far off, or because they don’t want to reduce their take-home pay. |
|
| Clearly, DC plans won’t pay off if you don’t pay in to them. But if you participate, take the long view, and invest wisely (by diversifying into stocks and bonds and taking full advantage of any employer matching) DC plans offer a solid source of retirement income. It’s important to note, though, that any withdrawals you make before age 59 1/2 will be subject to a 10% early withdrawal penalty and any distributions you make in retirement will be subject to income taxes. |
|
|
> Home
> Glossary > Support |
