What Is a Defined Contribution Plan?

A defined contribution plan is essentially a kind of retirement plan. In this retirement plan, the employee, employer or both make contributions regularly. Each participant is given an individual account, and the benefits are based on how much is contributed to the account.

How the Retirement Plan Works

In 2015, there was $6.7 trillion in DC plans out of $24 trillion in all retirement plans in the country. This type of contribution plan requires a certain percentage or numerical amount of money to be set aside from the company for its employees. Then, the plan sets restrictions on how much money can be withdrawn at certain times without a penalty. While the amount that is contributed to this plan is fixed, the amount received is not. Participants can calculate estimated withdrawals, but market fluctuations can affect the ultimate amount.

The most popular type of DC plan is the 401(k). this accounts for about two-thirds of all of these plans. An estimated 87 percent of the eligible employees at corporations take part within their company’s 401(k) plan. Depending on the type of plan, these contributions may be made pretax. The contributions can be made by employees with a set percentage matched by the employer.

While some people refer to these plans as pensions, they are not a true pension. An actual pension refers to a fixed amount that is paid to an individual or their dependents for past services. With a DC plan, the benefits are not fixed. Only the contributions to the plans are fixed at the outset of the arrangement. This means that the employee has less financial security, but the employer enjoys lower obligations. Because of this, many employers have switched from defined benefit plans to DC plans.

What Types of Plans Are Available?

The options available for employees will depend entirely on the employer. Often, a 401(k) option is offered to employees at businesses and public corporations. Federal government employees can use Thrift Savings Plans. Meanwhile, nonprofit corporations like schools often use 403(b) plans. Certain government employees and nonprofit businesses use 4576 plans. An individual retirement account (IRA) can also technically use defined contributions.

The Benefits of DC Plans

Depending on the plan, participants may be able to enjoy retirement growth on a tax-deferred basis. In a traditional DC plan, the contributions are pretax. This means that the withdrawals are taxable. If the company uses a Roth 401(k), then the contributions are taxable. The withdrawals are then tax-free under the right circumstances.

One of the best benefits of DC plans is the matching contribution. Depending on the employer, 50 to 100 percent of the employee’s contributions are matched by the company. Automatic participant enrollment makes taking part in retirement planning easier for the employee. Other benefits include loan provisions, automatic contribution increases and hardship withdrawals. If the employer is 50 years old or older, they can also benefit from catch-up contributions.

Saving for a retirement is a necessity, and a defined contribution plan make retirement planning easier. With the right retirement plan, employees can enjoy financial stability during their golden years.

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