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What are defined contribution plans and how do they work?

Defined contribution plans sound fancy, but they are the common retirement savings plans you come across all the time during employment. They include 401(k)s, 457s, 403(b)s and Thrift Savings Plans. These plans are typically sponsored by your employer and are called defined contribution plans because you contribute earnings to them as the employee.

A breakdown of the most common defined contribution plans is as follows:

- A 401(k) is the most common type of plan offered to a company's employees by the company. A Roth 401(k) is a subgroup of the 401(k) that comes with different tax rules.

- A 457s is a defined contribution plan for state and municipal employees. This plan can also be used for employees of nonprofit organizations.

- A 403(b) is a defined contribution plan for employees in the public education sector as well as some nonprofit organizations.

- A Thrift Savings Plan is for federal employees.

So, how does a defined contribution plan work? It is quite simple. You tell your employer how much money you want to contribute and then it is taking as a deduction from your paycheck and automatically deposited into your defined contribution plan without hassle.

The plan will have various investment options, but not a large variety, and you choose how you want the money deposited into the account to be invested. If you decide to leave the company, you still own the defined contribution plan.

A large number of employers will also contribute money into their employee's defined contribution plans. This is known as matching contributions. The amount will vary by employer and sometimes changes depending on the length of time the employee has been with the company.

A Roth 401(k) taxes the holder of the plan on the contributions made, not on the money when it is withdrawn. When you withdraw money from your 401(k) it is taxed at your income tax rate at the time of the withdraw.

Know your rights surrounding defined contribution plans in Oneida, New York prior to making any withdrawals.

Source: CNN Money, "What are defined contribution plans?," accessed March 01, 2017

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