Defined Contribution Plans

Editor's Note: Understand the basics of defined contribution plans.

Tracy MorleyOverview: 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 Employees pay taxes when money is withdrawn from the account (usually during retirement), at which time it is taxed as ordinary income.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

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HR guidance on understanding defined contribution plans.