How can employee contributions accumulate in a CODA plan?

In a Cash or Deferred Arrangement (CODA) plan, employee contributions can accumulate under a tax shelter. This means that contributions made by employees are typically made on a pre-tax basis, allowing the funds to grow without immediate taxation. This tax deferral is advantageous for employees because it reduces their taxable income in the year the contributions are made. They only pay taxes on the contributions and earnings when they withdraw the money, usually in retirement when they may be in a lower tax bracket.

The term "tax shelter" in this context refers to the legal provision that allows for favorable tax treatment of the amounts contributed to the plan. This helps employees save for retirement more effectively, as their money can benefit from potential investment growth without being diminished by taxes each year.

Contextually, other options lack the nuances of how contributions are treated in a CODA plan. Standard tax rates do not reflect the specific benefits provided under a tax shelter arrangement, and employee contributions do not accumulate with no restrictions as there are often limits defined by law on how much can be contributed. Additionally, the accumulation of contributions is not solely at the employer's discretion; employees decide to contribute, subject to plan guidelines.