What are Defined Contribution Plans?

Published by Thomas Herold in Retirement

'Defined Contribution Plans' is explained in detail and with examples in the Retirement edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Defined contribution plans turn out to be a specific type of retirement plan. In these, an employer’s yearly dollar amount contribution to the plan is spelled out clearly. Accounts are established on an individual basis for all employees participating. The amounts that are credited to such accounts include both the preset employer contributions, as well as any contributions coming from an employee. On top of this, earnings on investments are also accrued in defined contribution plan accounts.

With defined contribution plans, solely the contributions from employers are pledged to the accounts. Future benefits are not assured. In such plans, the benefits in the future go up and down based on the results of earnings on investments held in the plans.

Savings and thrift plans prove to be the most generally seen type of defined contribution plans. With this kind of a plan, employees put in to the account a pre arranged percentage of their typically pre taxed earnings. The monies go to the employee’s individual account. Part of the contributions, or all of them in some cases, are then matched up by the employee’s employer.

Once these pre set contributions are credited to the individual employees’ accounts from both employees and employers, these contributions are subsequently invested. They might be invested in to the stock market, for example. The resulting investment returns are finally appointed to the account on an individual basis. This is the case whether the returns prove to be positive or negative.

When retirement time arrives for an employee, the participant’s account then pays out benefits for retirement. This can occur through the account buying an annuity that will then assure a regular stream of income. In recent years, these defined contribution plans have expanded to be found in nearly all countries. For numerous nations, these are currently the main type of plan for the private sector retirement schemes. This growth in defined contribution plans has occurred at the expense of defined benefit plans, also known as pension plans, as employers seek to avoid the considerable expenses in funding and maintaining pension plans.

Money that is put into these defined contribution plans may come from employer contributions or salary deferral of an employee. These plans over time have evolved to become fairly easily portable from one job and company to the next as an employee changes companies. This did not always turn out to be the case.

One unique feature of defined contribution plans revolve around the rewards and risks of investments undertaken. Every employee is responsible for his or her own account’s performance, rather than the employer or sponsor of the plan. Besides this, employees are not made to buy annuities with the retirement savings. This means that they could theoretically live beyond their retirement assets, and they take on the risk of this possibility. In Great Britain, the law requires that the majority of the retirement funds be employed in buying an annuity so that this does not happen.

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The term 'Defined Contribution Plans' is included in the Retirement edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.