Employee Contribution Plan – Definition

Cite this article as:"Employee Contribution Plan – Definition," in The Business Professor, updated September 10, 2019, last accessed October 27, 2020, https://thebusinessprofessor.com/lesson/employee-contribution-plan-definition/.


Employee Contribution Plan Definition

An employee contribution plan is a savings plan that enables employees to keep a certain portion of their monthly or bi-weekly income aside as savings in an investment account. Though the federal government has imposed specific restrictions on the amount that employees can contribute to this plan, but there are many tax related benefits including deferred taxes on gains received on investments. Every contribution made by employees is owned by them completely. There are many organizations who tend to balance the contributions made by employees up to a given limit. However, the employee gets the ownership benefit of the complete matching contribution after working for a certain number of years for the organization.

Defined contribution plans including the 401(k), the 404(b), profit-sharing plans, and employee stock ownership plans are a part of employee contribution plans in the U.S. Different versions of 401(k) plans consist of the traditional 401(k), safe harbor 401(k), SIMPLE 401(k), and automatic enrollment. Traditional 401(k) has been one of the most famous 401(k) plans till date.

A Little More on What is an Employee Contribution Plan

Employee contribution plan works differently from a defined benefit plan. The former’s payout depends on the amount of funds contributed by the employee, if the employer is able to match a proportion of the contributions made, the investment strategy chosen by the employee, and the performance of those investments in a given timeframe. While in the latter one, the employee receives a fixed amount of incentives at the time of retirement. In employment contribution plans, it’s the employee and not the employer who has to bear the risk of investments. Also, the value or returns offered by the plan will depend on good or bad the investments perform.

Employers in association with the third-party plan managers organize employee contribution plans for employees. These managers perform the tasks of tracking records, offering different investment options to choose from, increasing awareness of employees about the plan, predicting disclosures, managing proxy voting, etc.

Employee Contribution Plan Investing

It is the right and responsibility of employees to determine what amount they want to invest in the employee contribution plan. They can select among a wide range of diversified portfolio options that involve a mix of equity and debt related mutual funds so as to gain more returns, and high capital gains. Employee contribution plans provide an array of local and global equity mutual funds, fixed income funds, target-date funds, and cash investments. Employees usually prefer investing in less-risky investments, however, there are a few plans that offer an alternative of self-directed brokerage or a company stock option that is even riskier in nature.

Around 66.67% of the U.S. employees don’t contribute to employee contribution plan. And the remaining ones don’t contribute adequately so as to get their complete organization match. As per the studies, even if administrators use the automatic enrollment feature for enabling employees to save conveniently, they succeed a little in motivating employees to make optimum use of plan. There are many employees who register to this plan at a rate that is less than optimal rate, and then, many of them are not successful at making changes to their default investment plan.

Employee contribution plans are governed by the rules and regulations of the Department of Labor and the Employee Retirement Income Security Act of 1974 (ERISA) in the United States.

Reference for “Employee Contribution Plan”




https://smallbusiness.chron.com › Managing Employees › Employees


Was this article helpful?