Defined Contribution Plan

Under a defined contribution plan, the employer makes a contribution to the plan on behalf of the employees. These contributions are allocated to individual account balances, which are separately established and maintained for each employee. These accounts are also credited with investment gains or losses. As a result, the employee bears the investment risk. The benefits under defined contribution plans are easy to understand. The value of an employee’s benefit is simply the current balance in the employee’s account at the time of distribution.

Under a defined contribution plan, the maximum annual amount that may be credited to an employee's account is limited to the lesser of 100% of compensation or $55,000 (for 2018). This limit is adjusted each year to reflect changes in the cost of living index. Furthermore, there is a maximum tax-deductible limit. The employer tax-deductible contributions cannot exceed 25% of the total compensation of all employees.

There are different types of Defined Contribution Plans. The most popular is the 401(k) plan. 

The different types of defined contributions are:

There has been an unprecedented growth in defined contribution plans for the past several years. These plans are very popular and highly visible for many reasons. For employers, these plans are cost effective and flexible, which allows employers to adjust funding requirement based on business circumstances. For employees, these plans are easy to understand.