11.3 Employer Plans: 401(k), 403(b), SEP, SIMPLE, Pension/Profit-Sharing
Key Takeaways
- Defined benefit (pension) plans promise a formula benefit and place investment risk on the employer; defined contribution plans promise only an input.
- The 2025 elective deferral limit for 401(k) and 403(b) plans is $23,500, plus a $7,500 catch-up at age 50 and older.
- 403(b) tax-sheltered annuities serve public schools and 501(c)(3) nonprofits and allow a special 15-year-of-service catch-up.
- Simplified Employee Pension (SEP) IRAs are employer-funded only, with a 2025 cap of the lesser of 25% of pay or $70,000.
- SIMPLE IRAs fit employers with 100 or fewer workers; the 2025 deferral limit is $16,500 with a $3,500 catch-up.
Two Families of Employer Plans
Every employer-sponsored qualified plan is either a defined benefit plan or a defined contribution plan. The distinction governs who carries the investment risk and what the worker is actually promised.
| Feature | Defined Benefit (DB) | Defined Contribution (DC) |
|---|---|---|
| Promise | A specific retirement income (formula) | A contribution amount only |
| Investment risk | Employer | Employee |
| Final benefit | Known in advance | Depends on contributions and returns |
| Funding | Actuarially determined | Defined input each year |
| PBGC insurance | Yes | No |
A traditional pension is the classic DB plan. A 401(k), 403(b), profit-sharing, SEP, and SIMPLE are all DC plans.
401(k) Plans
The 401(k) is the dominant private-employer plan. Employees elect to defer salary on a pre-tax (or Roth after-tax) basis, and employers may add a match or profit-sharing contribution.
| 2025 Item | Amount |
|---|---|
| Employee elective deferral | $23,500 |
| Catch-up, age 50+ | $7,500 |
| Total annual additions (all sources) | $70,000 |
Worked example: Dana, age 55, defers the full $23,500 plus the $7,500 catch-up, for $31,000 of her own money. Her employer adds a 4% match worth $6,000. Her total additions of $37,000 are well under the $70,000 ceiling, so all contributions are allowed.
A safe harbor 401(k) lets the employer skip the ADP/ACP nondiscrimination tests by promising a set match (for example, 100% of the first 3% plus 50% of the next 2%) that is immediately vested.
403(b) Tax-Sheltered Annuities
A 403(b) plan, historically called a Tax-Sheltered Annuity (TSA), serves a narrow set of employers:
- Public school systems (K-12 and public universities)
- 501(c)(3) tax-exempt organizations such as hospitals and charities
- Certain churches and their employees
Deferral limits mirror the 401(k) ($23,500 elective; $7,500 age-50 catch-up in 2025), but a 403(b) adds a unique perk: the 15-year service catch-up, allowing eligible long-tenured employees to contribute up to $3,000 more per year (subject to lifetime caps).
| Plan | Typical Employer | Special Catch-Up |
|---|---|---|
| 401(k) | For-profit company | None beyond age-50 |
| 403(b) | School / nonprofit | 15-year service catch-up |
Exam cue: If the question names a public school teacher or nonprofit hospital employee, the answer is a 403(b), not a 401(k).
A nurse employed by a nonprofit 501(c)(3) hospital with 20 years of service wants to maximize tax-deferred retirement savings. Which plan and feature should she expect?
SEP and SIMPLE Plans for Small Employers
Small businesses and the self-employed favor two streamlined arrangements that fund IRAs rather than trust-based plans.
A Simplified Employee Pension (SEP) IRA is funded only by the employer; employees make no salary deferrals. The 2025 cap is the lesser of 25% of compensation or $70,000. SEPs are flexible — the employer can vary or skip contributions year to year — and require almost no paperwork (no Form 5500).
A SIMPLE IRA (Savings Incentive Match Plan for Employees) suits employers with 100 or fewer workers. Employees defer up to $16,500 (2025), plus a $3,500 catch-up at age 50+. The employer must either match dollar-for-dollar up to 3% of pay or make a 2% non-elective contribution for everyone.
| Plan | Who Funds | 2025 Limit | Employer Size |
|---|---|---|---|
| SEP IRA | Employer only | Lesser of 25% pay or $70,000 | Any |
| SIMPLE IRA | Employee + employer | $16,500 deferral + $3,500 catch-up | 100 or fewer |
Pension and Profit-Sharing Plans
Traditional pension plans are defined benefit arrangements. The employer promises a formula benefit — for example, 1.5% × final average salary × years of service — and must fund it actuarially, bearing all investment risk. The Pension Benefit Guaranty Corporation (PBGC) insures these benefits within limits.
Worked formula: A worker with a final average salary of $80,000 and 30 years of service under a 1.5% factor earns an annual pension of 0.015 × $80,000 × 30 = $36,000 per year for life.
Profit-sharing plans are defined contribution plans where the employer makes discretionary contributions, often tied to profits, up to the $70,000 per-participant ceiling. A money purchase pension is similar but requires a fixed mandatory percentage each year.
| Plan | Contribution Style | Risk Bearer |
|---|---|---|
| Defined benefit pension | Mandatory, actuarial | Employer |
| Money purchase | Mandatory fixed % | Employee |
| Profit-sharing | Discretionary | Employee |
Which retirement plan is funded SOLELY by the employer and does NOT permit employees to make salary-deferral contributions?
SEP vs. SIMPLE Distinctions
Two small-employer plans are heavily tested. A SEP (Simplified Employee Pension) is employer-funded only into employees' IRAs, with a high contribution limit (a percentage of compensation up to an annual cap), ideal for self-employed and small firms. A SIMPLE plan allows employee salary-deferral plus a mandatory employer match (typically dollar-for-dollar up to 3% or a 2% nonelective contribution), is limited to employers with 100 or fewer employees, and has lower deferral limits than a 401(k).
401(k) Catch-Up and Vesting
401(k) plans allow pre-tax (or Roth) salary deferrals with employer matching; participants age 50+ may make catch-up contributions above the regular limit. Employer contributions follow a vesting schedule (cliff or graded), while employee deferrals are always 100% vested immediately. 403(b) plans serve public-school and 501(c)(3) nonprofit employees with similar deferral mechanics. All these plans require RMDs and impose the 10% early-withdrawal penalty before 59-1/2.
An employer with 60 employees wants a plan funded by employee salary deferrals plus a required employer match, with minimal administrative cost. The best fit is a: