What is a defined contribution plan?
A defined contribution plan is a retirement or pension plan that specifies the responsibilities of both the employer and the employee regarding how, when, and what amount of financial contributions may be made to the plan. Generally, the benefits received by the employee after retirement are determined by the amount of contributions made to the plan and any returns from investments that are conducted using the contributions. For the life of the defined contribution plan, the employer oversees the collection and investment of the funds connected with the fund. Defined benefit plans of this nature often include the potential for employer matching contributions. That is, there is a cap on how much the employee can contribute to the plan during the course of a calendar year. The employer may match that amount with an equal contribution or at least contribute a fixed percentage of that capped amount. This process allows the employee to make regular contributions to the plan, while also gain
According to Section 3(34) of ERISA, [an] “individual account plan” or “defined contribution plan” means a pension plan which provides for an individual account for each participant and for benefits based solely upon the amount contributed to the participant’s account, and any income, expenses, gains and losses, and any forfeitures of accounts of other participants which may be allocated to such participant’s account. Code section 414(i), other than leaving off the term “individual account plan” provides the same definition. By reading ERISA Section 3(35) or Code section 414(j), we learn that qualified plans that are not defined contribution plans are defined benefit (DB) plans. Generally, a defined contribution plan will take one of three forms – it may be a pension plan, a profit-sharing plan or a stock bonus plan (a fourth form exists, an annuity plan, but is uncommon in the corporate world). It turns out that there are other familiar names given to plans that fit into these categor
Employers have become less generous than they had been in the past with pension benefits. Corporate restructurings have left many people working for smaller businesses, which usually don’t offer generous pensions. Many big established companies have changed from, or rely less on, the more costly defined-benefit plans. Instead, many organizations now use the less expensive and more flexible defined-contribution plans. Defined contribution plans are actually a broad range of programs including profit-sharing plans, money-purchase plans, 401(k) plans, employee stock ownership (ESOP) plans and others. Either the participant alone, or the participant and his or her employer, make contributions into the plan, usually based on a percentage of annual earnings. Each participant has an individual, separate account. There is no way to determine in advance what the final payout at retirement will be. Benefits depend on how much was contributed in a participant’s name and how well the fund investme
