What is a Defined Contribution Plan?
In general, a defined contribution plan is a defined benefit plan, which is typically a funded by the employer or an entity other than the person who directly benefit from the plan.that people with their own (rather than an employer) and use to save for retirement. It is the opposite of a
How Does a Defined Contribution Plan Work?
A 401(k) plan is the most common type of defined contribution plan, though there are other types of similar plans for certain types of employees. For example, self-employed people might open a Keogh plan, or public employees might join a 403(b) plan.
The idea is the same, though: employees contribute a portion of their pay on a pre-taxin their own accounts. Employees choose how much they want to save per year, up to the maximum allowed by the plan. In many cases, employers match employee contributions up to a specified percentage and, in some cases, employers may additional contributions as part of an incentive package.
The defined contribution plan then invests thein a securities portfolio. The composition of the portfolio may vary depending on how the company manages its plan and the level of risk with which the employee is comfortable. In most cases, employees may choose from a variety of portfolio allocations.
At retirement age, the employee can begin withdrawing the. Should the employee choose or need to withdraw prior to retirement age, he may incur certain penalties specified in the plan.
Why Does a Defined Contribution Plan Matter?
A defined contribution plan gives employees the opportunity to invest theirin the securities markets for the purpose of setting aside for retirement without the burden of taxation. In addition, the plan's withdrawal restrictions serve as an incentive for employees not to use the and allow them to grow as much as possible.