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Understanding Defined Contribution Plans

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Understanding Defined Contribution Plans

There are two broad categories of tax-advantaged retirement plans: defined contribution and defined benefit. These two types are primarily differentiated based on the process in which they are funded and how participants are paid out benefits.

The IRS allows defined contribution plans to grow without being taxed.

The IRS allows defined contribution plans to grow without being taxed.

How does this matter within the context of precious metals bullion investing? The type of plan(s) that you participate in have an impact what investable assets you can contribute funds to, how and where you can rollover or transfer money, and ultimately how much you can protect your retirement.

Here, we’ll detail what a defined contribution plan is, how it works, who offers them and how you can add gold or other precious metals to your plan.

Defined Contribution vs. Defined Benefit Plan

Defined contribution plans  are structured so that the employee, employer, or both can make contribution (usually on a consistent, recurring basis) to a tax-deferred growth vehicle. These plans identify how much money is going to be contributed towards retirement today, not how much money will be available as a guaranteed benefit in retirement.

Most defined contribution plans offer a set of investment options which the account owner can choose from, have an IRS-imposed contribution limit, and assess a penalty on any money that is withdrawn before retirement age (usually 59.5).

Defined benefit plans act like traditional pensions — a certain guaranteed level of retirement income is made available to employees based on a formula. This formula usually will take into consideration the level of compensation during an employees working years, how long they worked for a given company, and (in a less direct sense) the profitability of the company.

Defined contribution plans provide investment control, in varying degrees, to the employee. In so doing, the employee assumes the investment risk, meaning that they have a significantly higher risk-reward factor than defined benefit plans.

The most common employer provided defined contribution plan is the 401(k).

The most common employer provided defined contribution plan is the 401(k).

Retirement plans are either established on an individual basis or are sponsored by an employer as part of a benefits package.

Employer Defined Contribution Plans

The most common and most well known employer-sponsored defined contribution plan is the 401(k). Named after section 401(k) of the Internal Revenue Code, nearly 95% of all private employers in the United States offer a 401(k) to at least some of their workforce.

The greatest advantage to participating in an employer-sponsored defined contribution plan is the possibility of receiving employer contributions through a ‘match program.’ For example, some employers offer a 50% match on up to 6% of employee contributions towards their 401(k) plan. In such a program an employee who earns $50,000 can contribute up to $3,000 (6%) and receive an additional $1,500 (50% of $3,000) from their employer. These dollars are essentially free retirement bonuses, and allow the employee to exceed standard 401(k) contribution limits.

Other examples of employer sponsored defined contribution plans include 403(b) plans, 457(b) plans, and SEP IRAs.

Personal Defined Contribution Plans

Some defined contribution plans can be established independent of an employer. The most common example is an Individual Retirement Account (IRA), which (almost) all income earning adults in the United States are eligible to open. IRAs share many of the same tax rules as 401(k) plans or other employer-sponsored plans, and like most defined contribution plans come with a Roth option.

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Personal defined contribution plans have different contribution limits and investment rules, but generally allow for much greater asset allocation freedom than do employer plans. The limitations on personal defined contribution plan investment choices are only those set by the IRS and by whichever financial intermediary is used as the custodian on the account. Most custodians are banks, but the IRS also allows certain nonbank entities to act as custodians.

The defined contribution plan with the most investment options, the greatest degree of individual account owner control, and the most effective means of owning physical bullion as a tax-advantaged investment is the Self-Directed IRA.

Adding Gold to Your Defined Contribution Plan

If you are looking to add approved gold or silver bullion to your retirement portfolio as a hedge against economic uncertainty and inflation, you should look into whether or not your plan allows for a rollover into a self-directed gold IRA.

Chris Thomas

About Chris Thomas

Chris Thomas is a Senior Editor at Gold IRA Guide. He is an experienced financial and investment author with a strong passion for commodity investing and global economics. Before joining the Gold IRA Guide team, Chris has been writing for various authority financial portals and magazines for over two decades.