What is a Defined-Contribution Plan
A defined-contribution plan is retirement plan that's typically tax-deferred, like a 401(k) or a 403(b), in which employees contribute a fixed amount or a percentage of their paychecks in an account that is intended to fund their retirements. The sponsor company will generally match a portion of employee contributions as an added benefit to help retain and attract top talent. These plans place restrictions that control when and how each employee can withdraw from these accounts without penalties.
Defined Contribution Plan
BREAKING DOWN Defined-Contribution Plan
There is no way to know how much the plan will ultimately give the employee upon retiring, as contribution levels can change and the returns on the investments may go up and down over the years.
Defined-contribution plans accounted for $6.7 trillion of the $24 trillion in total retirement plan assets held in the United States as of Dec. 31, 2015, and that number has risen in the past two years. According to the Investment Company Institute: "As of September 30, 2017, 401(k) plans held an estimated $5.3 trillion in assets and represented 19 percent of the $27.2 trillion in US retirement assets." The defined-contribution plan differs from a defined-benefit plan, also called a pension plan, which guarantees participants receive a benefit at a specific future date.
Advantages of Participating in a Defined-Contribution Plan
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), the account holder makes contributions after taxes, 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.
Employer-sponsored defined-contribution plans 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, but some companies match $1 for every $1 contributed up to a percentage of an employee's salary - generally 4 to 6 percent.
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 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 individual retirement accounts often entail defined contributions into tax-advantaged accounts with no concrete benefits, they could also be considered a defined-contribution plan.