Defined Contribution Plan Types

Retirement plans in which contributions are made by the employer, employee, or both. The final payout to the participant depends on how much is invested and the success of the investments.

• 401(k) Plan

  Named after a section of the 1978 Internal Revenue Service Code where it first apeared, this type of plan allows workers to make voluntary, tax-deductible contributions up to certain limits; the employee contributions may be matched by the employer. 401(k) plans let employees save for retirement easily and conveniently through pre-tax automatic payroll deductions. Employees have full control over their investment elections within the plan. All contributions and any gains are tax deferred until the time of withdrawal at retirement. Withdrawals are also permitted at termination of employment or during financial hardship, subject to penalties.

• Money Purchase Pension Plan

  Plan that requires a set amount (usually a percentage of the employee's salary) be contributed by the employer each year, even in years where there is no profit. Continued qualification under Internal Revenue Service Codes requires that employers make an annual contribution.

• Profit-Sharing Plan

  Plan that bases employer contributions on business profits or a percentage of pay. “Discretionary profit sharing” plans generally allow employers to decide each year whether to contribute.

• Target Benefit Plan

  Employer contributions are calculated to provide hypothetical projected benefits at retirement based on actuarial assumptions. The actual retirement benefit is based upon the participant's account balance at retirement. Similar to a Defined Benefit Plan (below), the annual contribution is calculated as the amount necessary to fund for a projected benefit at retirement, and similar to a money purchase plan (above), contributions are allocated to individual participant accounts. The actual retirement benefit is based upon the participants account balance at retirement age. The investment experience (gains/losses) will not result in any increase or decrease in employer contributions. Instead, such experience will increase or decrease the benefit payable to the participant.

Defined Benefit Plans

The Defined Benefit plan is designed to pay a fixed benefit amount upon retirement. The benefit amount is based on the formula outlined in the plan document. The contributions are actuarially determined on the anticipated benefit at retirement. The factors that determine the total contribution are current compensation, earnings on contributions, age and years of service. The contribution is the amount necessary each year to provide sufficient funds to pay the promised benefit. Money is paid into the plan for all participating employees, but some will not qualify for, and therefore will not get, benefits.

The employer assumes the investment risk in that if the assets fail to earn the rate of return that was used in the actuarial assumption, a greater contribution may be required the following year. Or, conversely, if the investments outperform expectations, the plan will have an actuarial gain, which may reduce future contribution requirements.