401 K plan is a retirement plan that is on offer in US and some other countries. This plan offers tax deferred savings to the employees and encourages them to save for retirement. It is also referred to as employer sponsored retirement plan.

A 401 K plan offers several tax deduction benefits to the employees. These benefits can be availed by all citizens (except in certain cases where the employer can impose certain restrictions). In cases of people with less than 1 year of service, non US citizens or part time workers, contributions to a 401 K plan depends upon the employer. For others the rules are common.

401 K plan offers tax deductions to the contributors. Under this plan all the contributions are tax deductible, that is, tax is not levied on the contributions. Even though contributions are made from non taxed salary, it is not entirely exempted from taxation. The funds (or tax deductions) are taxed at prevalent rates at the time of withdrawal. Therefore the savings are only tax deferred and not tax exempted.

401 K funds (or the tax deductions) are generally monitored by a third party. The annual contributions can be invested in a variety of stocks, funds, certificates and bonds. But it is up to the employer to provide these options to his/her employees. He has the sole discretionary power over the management of 401 K plan. The contributions to the plan can be matched by the employer also. He/she can contribute to the 401 K plan of his/her employees. This is generally done by the employers to retain the employees. Employer contributions are not included in the maximum limit on annual contributions of employees. Therefore they are over and above the salary of an employee.

The employer can provide the option of buying company stocks from these annual contributions. But investing the entire in amount in a single companies stocks, specially the one in which one is working, is not advisable. This would mean unnecessary risk and therefore should be avoided.

Usually this plan is offered by big companies only. This is because of the enormous costs involved in the administration of the plan. However, simpler options are available for self employed and former government entities also.

The maximum tax deductions possible are limited and set by the government. The employer can also impose his/her own limits for maximum employee contribution (or tax deductions). For example a firm may restrict the maximum contribution to 10% of the employees income. The governmental limit on maximum contribution generally depends on the inflation rate and varies every year. For people over 50 years of age, catch up limits are allowed. This allows people over 50 years to contribute more than others. For the year 2007, the maximum contribution limit for people below 50 years of age was $15,000. For people above 50 years of age this limit was set at $15,500.

When people think about their overall retirement strategy, they often include plans such as 401(k)s and IRAs. Many overlook the possibility of using a defined benefit plan as an additional tool for reaching their retirement goals. Defined benefit plans are often misunderstood, considered a thing of the past or erroneously thought to be appropriate only for large corporations. Defined benefit plans can provide a very rich retirement planning tool for small business owners, allowing them to maximize their contribution up to $200,000 or more.

What is a Defined Benefit Plan?
Defined benefit plans are retirement plans in which the employer promises to make specified benefit payments to qualifying employees at retirement.

There are Two Types of Defined Benefits Plans:
Pension Plans: A pension plan is a retirement plan in which participants are given a pre-determined monthly benefit amount provided they meet certain requirements. Monthly benefits are calculated based on age, years of service and income. An employer must maintain the plan at an adequate funding level to meet future benefit obligations.

Cash Balance Plans: A cash balance plan is a hybrid of defined benefit and defined contribution plans. An employer credits a participant’s account with a set percentage of his or her yearly compensation plus interest, and guarantees a contribution level and minimum rate of return.

Advantages of Offering a Defined Benefit Plan:
o Owners can contribute more than the 401(k) limits of $15,500/$46,000
o Owners have the option to overfund contributions (150%) in a good year
o Provides a powerful tool to retain high quality employees
o Allows for larger tax deductions compared to a defined contribution plan
o Employer contributions can be taken as a business expense deduction
o Allows an excellent way to provide retirement income to employees who have a short window before retiring (owners and mid-or late-career new hires)
o ERISA protects qualified plan assets from more creditors in the event of bankruptcy or lawsuit