11.3 Employer Plans: 401(k), 403(b), SEP, SIMPLE, Pension/Profit-Sharing
Key Takeaways
- A 401(k) is a defined contribution plan letting employees defer pre-tax salary, often with an employer match; the 2025 deferral limit is $23,500 plus a $7,500 catch-up at age 50+.
- A 403(b) (Tax-Sheltered Annuity) serves public schools and 501(c)(3) nonprofits with the same deferral limits as a 401(k).
- A Simplified Employee Pension (SEP) IRA is funded only by the employer, ideal for small businesses and the self-employed.
- A SIMPLE IRA suits employers with 100 or fewer employees and requires an employer match or nonelective contribution.
- Defined benefit (pension) plans promise a fixed retirement benefit and place the investment risk on the employer; defined contribution plans place that risk on the employee.
Employer qualified plans fall into two families based on who bears the investment risk.
Defined Benefit vs. Defined Contribution
| Feature | Defined Benefit (Pension) | Defined Contribution |
|---|---|---|
| Promise | A specific monthly benefit at retirement | An account balance, not a fixed benefit |
| Investment risk | Employer | Employee |
| Contribution | Actuarially determined | Set dollar/percentage amounts |
| Examples | Traditional pension, cash balance | 401(k), 403(b), SEP, SIMPLE, profit-sharing |
Exam anchor: In a defined benefit plan the benefit is defined and the employer carries the risk. In a defined contribution plan the contribution is defined and the employee carries the risk. The retirement nest egg is unknown until retirement.
The 401(k) Plan
A 401(k) is a defined contribution plan that lets employees defer a portion of salary on a pre-tax basis. Employers commonly add a matching contribution.
2025 limits:
- Elective deferral limit: $23,500
- Catch-up (age 50+): $7,500
- Total annual additions (employee + employer): $70,000
Worked match example: An employer matches 50% of deferrals up to 6% of pay. Renee earns $80,000 and defers 6% ($4,800). The match is 50% x $4,800 = $2,400, for a combined $7,200 added to her account. To capture the full match she should defer at least 6%.
The 403(b) — Tax-Sheltered Annuity (TSA)
A 403(b), also called a Tax-Sheltered Annuity (TSA), mirrors the 401(k) but is reserved for employees of:
- Public schools and colleges
- Tax-exempt 501(c)(3) organizations (churches, hospitals, charities)
It uses the same elective deferral and catch-up limits as a 401(k). Historically funded with annuities and mutual funds, the 403(b) is the nonprofit-sector counterpart to the corporate 401(k).
Exam trap: A for-profit company cannot offer a 403(b); it offers a 401(k). Match the plan to the employer type.
Plans for Small Employers: SEP and SIMPLE
Two IRA-based plans simplify retirement saving for small businesses.
| Feature | SEP IRA | SIMPLE IRA |
|---|---|---|
| Full name | Simplified Employee Pension | Savings Incentive Match Plan for Employees |
| Who contributes | Employer only | Employee deferrals + employer |
| Best for | Self-employed, small firms | Employers with 100 or fewer employees |
| Employer obligation | Discretionary, up to 25% of pay | Required: 3% match OR 2% nonelective |
| 2025 employee deferral | None (employer-funded) | $16,500 ($3,500 catch-up at 50+) |
- A SEP IRA is funded entirely by the employer and is prized for its flexibility — the employer can skip contributions in lean years.
- A SIMPLE IRA allows employee deferrals and forces the employer to either match up to 3% of pay or make a 2% nonelective contribution for all eligible employees.
Profit-Sharing and Pension Plans
- A profit-sharing plan is a defined contribution plan where the employer makes discretionary contributions (often tied to profits) allocated among participants. Contributions can vary year to year.
- A traditional pension is a defined benefit plan that promises a formula-based monthly benefit, typically based on years of service and final average salary.
- A cash balance plan is a defined benefit plan that looks like a defined contribution plan: each participant has a hypothetical account credited with pay credits and interest credits, but the employer still bears the investment risk.
Defined benefit formula scenario: A pension pays 1.5% x years of service x final average salary. With 30 years of service and a $90,000 final average salary: 1.5% x 30 x $90,000 = $40,500 per year.
An employer matches 50% of employee 401(k) deferrals up to 6% of compensation. An employee earning $80,000 defers 6% of pay. What is the employer's matching contribution?
Which retirement plan is funded solely by the employer and is most appropriate for a self-employed individual or very small business seeking contribution flexibility?
2026 Contribution Limits and the Catch-Up Rules
Memorize the structure of the elective-deferral and small-employer limits (indexed annually; use the figures your exam supplies):
| Plan | Elective deferral | Age 50+ catch-up |
|---|---|---|
| 401(k) / 403(b) | ~$23,500 | additional ~$7,500 |
| SIMPLE IRA | ~$16,500 | additional ~$3,500 |
| SEP IRA | employer-only, up to 25% of comp (capped) | n/a (no employee deferral) |
Key distinctions: a SEP is funded only by the employer and is easy to administer; a SIMPLE allows employee deferrals plus a mandatory employer match (up to 3%) or 2% nonelective contribution and is limited to employers with 100 or fewer employees. A 403(b) is for public schools and 501(c)(3) nonprofits and was historically an annuity-based tax-sheltered annuity (TSA). All defer tax until distribution, when withdrawals are taxed as ordinary income and pre-59 1/2 withdrawals face the 10% penalty.