What is a 'Defined-Contribution Plan'
A defined-contribution plan is a retirement plan in which a certain amount or percentage of money is set aside each year by a company for the benefit of each of its employees. The defined-contribution plan places restrictions that control when and how each employee can withdraw these funds without penalties.
BREAKING DOWN 'Defined-Contribution Plan'There is no way to know how much the plan will ultimately give the employee upon retiring. The amount contributed is fixed, but the benefit is not.
Defined-contribution plans account for $6.7 trillion of the $24 trillion in total retirement plan assets held in the United States as of Dec. 31, 2015. The most popular defined-contribution plan option is the 401(k), accounting for more than two-thirds of the defined-contribution plan total. More than 87% of eligible employees at corporations participate in their company 401(k) plan. The defined-contribution plan could be considered the opposite of the defined-benefit plan, which has participants receiving a guaranteed benefit at a specific future date.
Advantages of Participating
Contributions made to defined-contribution plan may be tax-deferred. In traditional defined-contribution plans, contributions are tax-deferred, but withdrawals are taxable. In the Roth 401(k), contributions are taxable, but withdrawals are tax-free if certain qualifications are met. The tax-advantaged status of defined-contribution plans generally allow balances to grow larger over time compared to taxable accounts.
Defined-contribution plans offered through employers may also receive matching contributions. More than three-fourths of companies contribute to employee 401(k) accounts based on the amount the participant contributes. The most common employer matching contribution is 50 cents per $1 contributed up to a specified percentage, while several contribute $1 for every $1 contributed.
Other features of many defined-contribution plans include automatic participant enrollment, automatic contribution increases, hardship withdrawals, loan provisions, and catch-up contributions for employees age 50 and older.
Other Defined-Contribution Plan Examples
The 401(k) is perhaps most synonymous with the defined-contribution plan, but there are many other plan options. The 401(k) plan is available to employees of public corporations and businesses. The 403(b) plan is typically available to employees of nonprofit corporations, such as schools. 457 plans are available to employees of certain types of nonprofit businesses as well as state and municipal employees. The Thrift Savings Plan (TSP) is used for federal government employees. As of Dec. 31, 2015, roughly $2 trillion in assets were held in non-401(k) account types.
Since the individual retirement account (IRA) often entails defined contributions into a tax-advantaged account with no concrete benefit, it could also be considered a defined-contribution plan.