DEFINITION of Retirement Contribution
A retirement contribution is a monetary contribution to a retirement plan. Retirement contributions can be pretax or after tax, depending on whether the retirement plan is qualified, how much the contribution is in relation to the contributor's income, and whether the contributor has made previous contributions that would limit tax deductibility.
BREAKING DOWN Retirement Contribution
In many corporate, private and government retirement plans, an employee's retirement contribution is matched in some way by the employer. This is referred to as an employer match, rather than a contribution.
Investing for Retirement
For better or worse, the retirement contribution now forms the bedrock of America's retirement system. At the end of the 1960s, some 88% of private sector workers who had a workplace retirement plan had a pension, according to the National Pension Public Coalition. That number by 2016 had fallen to 33% and much of that total is accounted for by workers at various levels of state and federal government.
The decline in pensions coincided with the rise of 401(k) retirement plans that began to take off in the 1980s. The major difference between a 401(k) and a pension (also known as a defined benefits pension plan) is that with the latter, corporations and government guaranteed a fixed payout to retirees. With a 401(k) (called a defined contribution plan) or IRA it's up to the employee to make the investment decisions and shepherd the growth of the account.
For employees, the retirement contribution can have vast consequences down the road. Those who are able to contribute at least 10% or their income (better yet 12% or 15%) over the their working lives and invest the money in a broad range of stocks have a good chance of funding a comfortable retirement. Those who put little or nothing aside or who invest too conservatively (eg, money markets and low-interest bonds) are more likely to find themselves depending almost entirely on a Social Security system that is projected to run out of funds in 2034.
Keep in mind that 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.
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.