What is a Defined Contribution Plan?

It is a retirement benefit plan where the employees make a contribution each month until retirement to fund their retirement plans. For individual accounts set up for this plan, employees contribute a fixed percentage of their monthly salary to fund this account. The employers may also contribute a matching portion to this account in order to offer an attractive retirement benefits package to their employees.

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How Does the Defined Contribution Plan Work?

More than 75% of the companies in the U.S. contributes towards the pension account of the employees. Usually, the ratio of employees contribution and employers contribution is 2:1 up to a certain percentage. Some may pay even more depending on the terms of the benefit plan. The retirement benefit is calculated on the credited amount in the account and investment earnings of that amount. As the investment earning varies with time, the benefit may also fluctuate. It is impossible to calculate the ultimate benefit amount the employees will get upon retirement. Traditionally, the defined contribution plans have a tax-free contribution and taxable withdrawals. There are also defined contribution plans where the contribution amount is taxable, but the withdrawal is tax-deferred. There are strict rules for the employees regarding withdrawing funds from these accounts. Defined contribution plan may also have certain provisions including automatic enrollment, automatic contribution hikes, hardship withdrawals, loan options and catch-up contributions for employees older than 50. These terms are defined by the nature of the plan.

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