11.3 Employer Plans: 401(k), 403(b), SEP, SIMPLE, Pension/Profit-Sharing
Key Takeaways
- Defined benefit (DB) plans promise a formula-based benefit and put investment risk on the employer; defined contribution (DC) plans fund an account and put risk on the employee.
- The 2025 elective deferral limit for 401(k) and 403(b) is $23,500, plus a $7,500 catch-up at 50 and an $11,250 enhanced catch-up at ages 60-63.
- 403(b) Tax-Sheltered Annuities serve public schools and 501(c)(3) nonprofits and add a 15-year service catch-up of up to $3,000.
- SEP plans are employer-funded only (up to 25% of pay or $70,000); SIMPLE plans allow employee deferrals of $16,500 with a required employer match or 2% non-elective contribution.
- Safe harbor 401(k) designs use specified employer contributions to automatically pass ADP/ACP nondiscrimination testing.
Two Families: Defined Benefit vs. Defined Contribution
Every employer plan is either a defined benefit (DB) plan or a defined contribution (DC) plan. The exam hinges on who bears the investment risk and what is promised.
| Feature | Defined Benefit (DB) | Defined Contribution (DC) |
|---|---|---|
| What is promised | A specific benefit (formula) | A contribution amount |
| Investment risk | Employer | Employee |
| Benefit known in advance | Yes | No -- depends on returns |
| Funding | Actuarial, employer-funded | Set contributions |
| Pension Benefit Guaranty Corporation (PBGC) insurance | Yes | No |
| Examples | Traditional pension | 401(k), profit-sharing, SEP, SIMPLE |
A classic DB final-average formula might be 1.5% x final-5-year-average salary x years of service. With a $100,000 average salary and 30 years: 0.015 x $100,000 x 30 = $45,000 per year for life -- a benefit the employer must fund regardless of market performance.
401(k) Plans
The 401(k) is the dominant private-sector DC plan. Employees defer salary pre-tax (or Roth after-tax), and employers often match.
| Feature (2025) | Detail |
|---|---|
| Employee elective deferral | $23,500 |
| Catch-up at age 50+ | $7,500 |
| Enhanced catch-up ages 60-63 | $11,250 |
| Total annual additions (all sources) | $70,000 |
Nondiscrimination Testing and Safe Harbor
Standard 401(k)s must pass the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests so HCEs do not defer far more than rank-and-file workers. A safe harbor 401(k) automatically passes these tests if the employer makes a required, immediately vested contribution.
| Safe Harbor Option | Employer Contribution |
|---|---|
| Basic match | 100% of first 3% + 50% of next 2% |
| Enhanced match | 100% of first 4% |
| Non-elective | 3% of pay to all eligible employees |
Match math: An employee earning $80,000 defers 5%. A basic safe harbor match gives 100% of the first 3% ($2,400) plus 50% of the next 2% ($800) = $3,200 of employer money.
403(b) Tax-Sheltered Annuities
A 403(b), also called a Tax-Sheltered Annuity (TSA), is the nonprofit-sector cousin of the 401(k). Eligible sponsors are:
- Public schools (K-12, colleges, universities)
- 501(c)(3) tax-exempt organizations (charities, hospitals)
- Churches and certain ministers
| Feature (2025) | Detail |
|---|---|
| Elective deferral | $23,500 |
| Age 50+ catch-up | $7,500 |
| 15-year service catch-up | Up to $3,000 extra (lifetime cap $15,000) |
| Total additions | $70,000 |
Investments are limited to annuities (fixed and variable) and mutual fund custodial accounts, which is why insurance producers see 403(b) business so often.
Exam Tip: If the participant is a public-school teacher or hospital nurse, the plan is a 403(b), not a 401(k). The 15-year catch-up is unique to 403(b)s.
SEP and SIMPLE Plans (Small Employer)
Small businesses use simplified plans that avoid heavy administration.
Simplified Employee Pension (SEP-IRA)
| Feature (2025) | Detail |
|---|---|
| Contributions | Employer ONLY |
| Limit | Lesser of 25% of pay or $70,000 |
| Self-employed effective rate | ~20% of net self-employment income |
| Form 5500 filing | Not required |
| Flexibility | Amount can vary year to year |
SIMPLE IRA (Savings Incentive Match Plan for Employees)
For employers with 100 or fewer employees; the employer may not maintain another qualified plan.
| Feature (2025) | Detail |
|---|---|
| Employee deferral | $16,500 |
| Age 50+ catch-up | $3,500 |
| Enhanced catch-up 60-63 | $5,250 |
| Employer match | Dollar-for-dollar up to 3% of pay, OR |
| Employer non-elective | 2% of pay for all eligible employees |
| Early-withdrawal trap | 25% penalty if withdrawn within the first 2 years |
Trap: SEP contributions are employer-only -- employees cannot defer salary into a SEP. SIMPLE plans do allow employee deferrals.
Pension and Profit-Sharing Plans
Two more DC designs round out the chapter:
- Profit-sharing plan: Employer contributions are discretionary -- the company decides each year, often tied to profits -- up to 25% of covered payroll and the $70,000 per-participant cap. Good fit for businesses with uneven cash flow.
- Money purchase pension plan: Contributions are a fixed, mandatory percentage stated in the plan document, owed even in bad years. It trades flexibility for predictability.
| Plan | Contribution Style | Per-Participant Cap (2025) |
|---|---|---|
| Profit-sharing | Discretionary, can be $0 in a year | $70,000 |
| Money purchase | Fixed % required every year | $70,000 |
| Defined benefit | Actuarially determined | Benefit cap $280,000/yr |
Both DC designs use the standard ERISA vesting schedules (3-year cliff or 6-year graded) for employer money, while a traditional DB pension is insured by the PBGC -- a guarantee that does not extend to any DC plan.
A registered nurse at a 501(c)(3) nonprofit hospital wants to defer salary into her employer's retirement plan and may also use a special 15-year service catch-up. Which plan is this?
Under a basic safe harbor 401(k) match (100% of the first 3% plus 50% of the next 2%), how much employer match does an employee earning $80,000 receive if she defers 5% of pay?