The Big Picture: Two Categories
Every qualified retirement plan is either Defined Benefit (DB) or Defined Contribution (DC). The choice of category determines who bears the investment risk.
| Defined Benefit (DB) | Defined Contribution (DC) | |
|---|---|---|
| Who bears risk | Employer | Employee |
| Benefit known? | Yes — formula-based | No — depends on returns |
| PBGC insured? | Yes | No |
| Best for | Older owners wanting large, fast contributions | Younger workforce; flexibility |
| Portability | Lower | Higher (rollovers easy) |
Decision Tree: Which Plan?
Step 1 — Does the employer want to retain all control of contributions?
- Yes, and they want maximum benefit for owner: Consider DB Pension or Cash Balance plan.
- No, want employee deferrals too: Consider 401(k), SIMPLE IRA, or 403(b).
Step 2 — How many employees?
- 1–100 employees: SIMPLE IRA is eligible.
- Self-employed or few employees: SEP-IRA is highly efficient.
- Any size: 401(k) works for any size employer.
Plan-by-Plan Breakdown
Defined Benefit (DB) Pension
- Benefit = formula based on years of service and compensation.
- Employer bears ALL investment risk — must fund the promised benefit.
- PBGC insured (Pension Benefit Guaranty Corporation).
- Highest possible annual benefit: lesser of $275,000 (2024) or 100% of average of 3 highest consecutive compensation years.
- Best for: Older business owners who want to sock away large amounts quickly and catch up on retirement savings.
Cash Balance Plan (Hybrid)
- Technically a DB plan, but looks like a DC plan to participants — they see a "hypothetical account balance."
- IRS sets the formula: employer credits a pay credit + interest credit each year.
- More portable than traditional DB; participants often receive a lump sum on separation.
- PBGC insured.
Exam Tip: Cash Balance plans are the fastest-growing plan type for professional firms (doctors, attorneys). The exam often tests that they are DB plans — not DC — despite looking like account balances to participants.
Target Benefit vs. Money Purchase (DC Plans)
| Target Benefit | Money Purchase | |
|---|---|---|
| Contribution | Adjusts each year to hit target | Fixed % of compensation every year |
| Employee bears investment risk | Yes | Yes |
| Formula | Actuarially determined | Flat % (e.g., 10% of salary) |
| Mnemonic | "Target = Tweaks contributions" | "Money Purchase = Mandatory fixed %" |
SIMPLE IRA
- Available to employers with 100 or fewer employees who received at least $5,000 in compensation last year.
- Allows employee deferrals (up to $16,000 in 2024; $19,500 age 50+).
- Employer must either match 100% up to 3% of compensation OR contribute 2% nonelective for all eligible employees.
- 2-year rule: Withdrawals within the first 2 years of participation face a 25% penalty (instead of the usual 10%).
- Cannot have any other qualified plan in the same year.
SEP-IRA
- Employer only contributions — employees cannot make their own deferrals.
- Contribution limit: lesser of 25% of compensation or $69,000 (2024).
- Eligibility: age 21, 3 of last 5 years of service, minimum $750 in compensation.
- Integrates with Social Security (can use permitted disparity).
- Easy to set up; no annual filing requirements (unlike 401k's Form 5500).
401(k)
- Most flexible plan — allows employee deferrals ($23,000 in 2024; $30,500 age 50+) plus employer match/profit sharing.
- Total contribution limit: $69,000 (2024) or 100% of compensation.
- Requires annual nondiscrimination testing (ADP/ACP) unless Safe Harbor.
- Safe Harbor 401(k): employer contributes fixed match or 3% nonelective; ADP/ACP testing waived.
Memory Trick: "SIMPLE is for Small businesses (100 or fewer). SEP is for Self-employed simplicity (no employee deferrals needed). 401(k) is for when you want it ALL — deferrals + matching."