What Is A Defined Contribution Plan?

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Kate Ashford Contributor

I'm a freelance journalist, content creator and regular contributor to Forbes and Monster.[author_bio_separator] I've written for AARP, the BBC, Family Circle, LearnVest, Money, Parents and Prevention, among others. Find me at kateashford.com or foll.

Written By Kate Ashford Contributor

I'm a freelance journalist, content creator and regular contributor to Forbes and Monster.[author_bio_separator] I've written for AARP, the BBC, Family Circle, LearnVest, Money, Parents and Prevention, among others. Find me at kateashford.com or foll.

Kate Ashford Contributor

I'm a freelance journalist, content creator and regular contributor to Forbes and Monster.[author_bio_separator] I've written for AARP, the BBC, Family Circle, LearnVest, Money, Parents and Prevention, among others. Find me at kateashford.com or foll.

Contributor

Ben is the Retirement and Investing Editor for Forbes Advisor. With two decades of business and finance journalism experience, Ben has covered breaking market news, written on equity markets for Investopedia, and edited personal finance content for B.

Ben is the Retirement and Investing Editor for Forbes Advisor. With two decades of business and finance journalism experience, Ben has covered breaking market news, written on equity markets for Investopedia, and edited personal finance content for B.

Ben is the Retirement and Investing Editor for Forbes Advisor. With two decades of business and finance journalism experience, Ben has covered breaking market news, written on equity markets for Investopedia, and edited personal finance content for B.

Ben is the Retirement and Investing Editor for Forbes Advisor. With two decades of business and finance journalism experience, Ben has covered breaking market news, written on equity markets for Investopedia, and edited personal finance content for B.

Updated: Nov 6, 2023, 5:59pm

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What Is A Defined Contribution Plan?

A defined contribution plan is an employer-sponsored retirement plan funded by money from employers and employees. The money you save for retirement in a defined contribution plan is invested in the stock market, and you may also get valuable tax breaks when you make contributions.

How Does a Defined Contribution Plan Work?

A defined contribution plan is sponsored by an employer, which typically offers the plan to its employees as a major part of their job benefits.

It’s called a “defined contribution” plan because workers who participate in the plan kick in specific—or defined—amounts of money to their accounts. In many cases, the company also contributes. Often, only the employer or the employee contributes to individual accounts.

Defined contribution plans come with valuable tax benefits. These may include pretax contributions that reduce an employee’s taxable income—plus potential tax-write offs for the employer. Alternatively, plans can allow post-tax Roth contributions, which can give an employee tax-free income in retirement.

Either way, contributions are sheltered from taxation while they remain in an employee’s account, year by year.

Companies manage defined contribution plans on behalf of their employees, and choose the various options offered by the plan. Employers often farm out the day-to-day operation of a plan to an outside professional manager—the Fidelity Investments, Vanguards and Capital Groups of the financial world. Employers decide whether or not they want to make contributions to their employees’ accounts. Employer contributions can include profit sharing, safe harbor contributions or matching contributions.

Employees can decide whether or not they want to participate in their employer’s defined contribution plan. If they choose to participate, they decide what percentage of their salary to contribute, and select different investments for their own account, most commonly a curated selection of mutual funds, including index funds.

Income in retirement entirely depends on the contributions saved in the account and the performance of an employee’s investment choices.

Defined Benefit Plan vs. Defined Contribution Plan

Traditional pension plans are known technically as defined benefit plans. They work differently from defined contribution plans. While a defined contribution plan puts most of the responsibility for contributing money and managing investments on the employee, a defined benefit plan is run by the employer.

The “defined” part of a defined benefit plan is, well, the benefit. Workers and employers know the size of each expected pension payout—or the formula for determining every payment payout—upfront. A defined benefit plan guarantees a specific amount of money employees can expect to receive as income each month in retirement, whether that’s an exact dollar amount or a percent of salary averaged over particular earning years.

Not all defined benefit plans are traditional pension plans, but traditional pension plans are the most familiar type of defined benefit plans. Generally, employers make the bulk of contributions to a traditional pension plan, rather than the employee.

Pension plans used to be common in the workplace—at one point, the vast majority of private sector workers had one. Today, only 21% of workers participate in a pension plan—depending on whose head count you’re looking at. And most pension plans are for state and local government workers. Twice as many workers (43%) participate in a defined contribution plan.

Defined contribution plans are largely funded by employee contributions, and they offer no guaranteed return of income in retirement. Unlike defined benefit plans, however, they generally offer the employee control over investments made with the plan contributions.

Defined Contribution Plan Advantages

A defined contribution plan offers certain advantages, from tax benefits to high contribution limits.

Defined Contribution Plan Disadvantages

A defined contribution plan, however, isn’t without its downsides.

Types of Defined Contribution Plans

Many of the retirement plans you’re already familiar with are defined contribution plans. While there are a variety of defined contribution plans, most of them offer very similar features; their different names primarily indicate the kinds of companies they’re sponsored by. Types of defined contribution plans include:

Defined Contribution Plan Contribution Limits

Contributions are at the heart of all defined contribution plans. Here are employer and employee annual contribution limits for 2023:

Here are those limits for 2024: