Over the past 50 years, there has been a dramatic shift in funding retirement for the average American. Most people rely on savings and few have pensions available to them. One of the most common ways to save is through a retirement savings plan offered by your employer; the most common is the 401(k) plan. These plans are designed to incent you to save every year, often with contributions from your employer, with the goal of maintaining a comfortable lifestyle in retirement.
What are defined contribution plans?
A 401(k) plan is one kind of defined contribution plan. In a defined contribution plan, the employer, employee, or both make regular contributions to the plan. The money is invested, and taxes are deferred until withdrawal. The retirement benefit is the balance in the account.
Other types of defined contribution plans include the 403(b) plan, simplified employee pension (SEP), and savings incentive match plan for employees (SIMPLE). In general, both employers and employees can contribute to these plans to a maximum of $72,000 for 2026 (in addition to a “catch-up” contribution, if eligible). Certain plan designs, such as including a profit-sharing feature, can help selfemployed and small business owners build up their own retirement nest eggs and provide options for the deferral of taxable income, as well as enhanced employee benefit packages.
“Defining” defined benefit plans
A defined benefit plan, as the name suggests, is designed to fund a certain level of retirement income at a future date. It is funded by annual contributions based on the individual’s age, income, length of time until retirement, and rate of return on the fund’s investments. The contribution amount is determined each year by actuarial calculations. For 2026, the funded benefit payable at retirement can be as much as $290,000, based on up to $360,000 of annual compensation. The plan is funded entirely by employer contributions, which are generally 100% tax-deductible. For a business owner close to retirement age, the required contribution can be considerable, along with the tax deduction. Annual contributions are mandatory, and if the business has other employees, contributions have to be made for them, too. A defined benefit plan is more costly than many retirement plans but allows for greater contributions than most other plans.
Cash balance plans
An alternative to a traditional defined benefit plan is the cash balance plan. It is a type of defined benefit plan that also has features of a defined contribution plan. The benefit is represented as an account balance rather than a monthly pension. (This is hypothetical; there are no actual individual accounts.) At retirement, a participant can take an annuity based on the account balance or, if the plan permits, a lump sum, which can be rolled into an individual retirement account (IRA) or another qualified plan.
Like traditional defined benefit plans, a cash balance plan can allow for significant contributions that are tax-deductible to the employer. The contribution limit varies by the age of the participant, and for those nearing retirement age, it can be over $200,000. As it is a type of defined benefit plan, annual employer contributions are mandatory, while employee contributions are not permitted. Contributions must be made for all employees, but the plan can be designed using a class-based benefit formula, which allows different benefit credits for different classes of employees. Given this, business owners can receive a higher benefit than rank-and-file employees, which can make it an attractive retirement planning vehicle from a savings and tax deductibility perspective.
The timing for tax deductibility of various retirement planning vehicles can vary. In the case of a cash balance plan, it must be established prior to year end for your contribution to be counted for the current tax year and to receive the benefit of deferring the recognition of income; however, you have until your tax filing date to fund the plan.
Individual retirement accounts
Traditional IRAs allow for less in annual contributions and remain subject to income limitations for determining deductibility when the individual or his or her spouse is covered by an employer-sponsored plan. The current contribution limit is $7,500 per year, with a $1,100 “catch-up” contribution, which is an additional contribution allowed by people aged 50 or older. The Secure Act 2.0, passed in 2022, adjusted this catch-up contribution limit for inflation in increments of $100, effective starting in 2024. The IRA contribution limit applies to traditional and Roth accounts together; the combined contributions cannot exceed the limit.
Roth IRA contributions are not deductible, but contributions to a traditional IRA may be, depending on circumstances. If neither the IRA owner nor the spouse is an “active is tax-deductible. If the individual or his or her spouse does spouse can also make up to a full ($7,500 or $8,600) range of income. If only one spouse is employed, the working Roth IRA contributions are not deductible, but contributions to a traditional IRA may be, depending on circumstances. If participant” in a retirement plan at work, the entire contribution have coverage at work, IRA deductibility is phased out over a contribution to a spousal IRA, provided he or she has sufficient earned income.
The IRS has a strict definition of being an “active participant” in an employer plan. For plans such as SEPs, 401(k)s, profit sharing, etc., a person is an active participant if any contribution or forfeiture allocation is made, no matter the amount and regardless of whether or not the person is vested in the contribution. For a defined benefit plan, one is an active participant if eligible under the rules of the plan, even if the person has declined to participate. If a person is an active participant for any part of the year, he or she is considered an active participant for the entire year.
And, depending on the type of plan, timing is also a factor: for some plans, participation is considered in the year the deposit is made, even if it is for a prior year, while other plans consider an individual an active participant in the year for which the contribution is made, regardless of when it is actually deposited.
Data source: 
Home | Internal Revenue Service.
This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any business/estate planning or investment strategy is suitable for a specific business or investor. This article is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.
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