Overview: A defined contribution (DC) plan is a plan that establishes an individual account for each participant. Employees may make contributions to their individual accounts through either pre- or post-tax contributions. Employers may add to accounts by offering to match a certain percentage of employee contributions or by making a discretionary contribution.
DC plans do not promise a specific benefit at retirement - the contribution itself is defined. Individual accounts are credited with contributions and actual investment earnings. In most cases, the employee controls how contributions are invested and he or she is able to choose from a variety of investment vehicles. The benefit an employee receives in retirement depends on how much the participant contributes and how well the investments perform.
Employee and employer contributions to a DC plan are tax deferred. Employees pay taxes when money is withdrawn from the account (usually during retirement), at which time it is taxed as ordinary income. With limited exceptions, withdrawals from a DC plan are generally not permitted until an individual reaches age 59 and one-half. Withdrawals made prior to age 59 and one-half usually incur a 10 percent excise tax in addition to ordinary income taxes.
Trends: Today, DC plans are the primary retirement plan for most employees. Employers continue to be dedicated in their efforts to educate employees on the value of participation. More and more employers are using auto-enrollment and escalation features, with life-cycle funds as the default investment option, as a means to helping employees invest for the future.
Author: Tracy Morley, SPHR, Legal Editor
Updated to reflect new IRS guidance on making mid-year changes to a safe harbor 401(k) plan without losing safe harbor status.
The Internal Revenue Service (IRS) has announced the tax year 2016 cost-of-living adjustments affecting dollar limitations on benefits and contributions under qualified retirement plans and other inflation-adjusted amounts. The pension plan limitations will not change for 2016 because the increase in the cost-of-living index did not meet the statutory thresholds that trigger their adjustment
Notice 2012-76 should be used by plan sponsors and practitioners submitting determination letter applications from February 1, 2013, through January 31, 2014.
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HR guidance on understanding defined contribution plans.