Defined Contribution

Lesson

Defined contribution plans are qualified retirement plans that allow employees to contribute a portion of their salary to a retirement account, often with employer-matching contributions. The final retirement benefit depends on the performance of the investments in the account.

Practice Question #1

Which of the following is a type of defined contribution plan?

A) 401(k) Plan

B) Pension Plan

C) Annuity

D) Social Security

Select an option above to see an explanation here.

A) A 401(k) plan is a defined contribution plan allowing employees to contribute pre-tax dollars to a retirement account. B) A pension plan is a defined benefit plan that provides a fixed monthly income during retirement. C) An annuity is a financial product that provides a series of payments over time, often used for retirement income. D) Social Security is a government program that provides retirement, disability, and survivor benefits.

Terms

Defined Contribution Plan:: A retirement plan in which the employee contributes a portion of their salary to a retirement account, and the final benefit depends on the performance of the investments in the account.
401(k) Plan:: A defined contribution plan allowing employees to contribute pre-tax dollars to a retirement account.
403(b) Plan:: A defined contribution plan for employees of non-profit organizations, such as schools and hospitals.
457 Plan:: A defined contribution plan for state and local government employees.
Profit-Sharing Plan:: A defined contribution plan in which the employer contributes a portion of the company's profits to the employee's retirement account.
Employee Stock Ownership Plan (ESOP):: A defined contribution plan in which the employer contributes company stock to the employee's retirement account.

Practice Question #2

What is the process by which an employee becomes entitled to the employer's contributions to their retirement account?

A) Rollover

B) Vesting

C) Required Minimum Distribution

D) Profit-Sharing

Select an option above to see an explanation here.

A) Rollover is transferring retirement account assets from one plan to another without incurring taxes or penalties. B) Vesting is the process by which an employee becomes entitled to the employer's contributions to their retirement account. C) Required Minimum Distribution is the minimum amount to be withdrawn from a retirement account each year, starting at age 72. D) Profit-Sharing is a defined contribution plan in which the employer contributes a portion of the company's profits to the employee's retirement account.

Do Not Confuse With

Defined Benefit Plan:: A retirement plan in which the employer guarantees a specific retirement benefit based on factors such as salary and years of service.
Pension Plan:: A defined benefit plan that provides a fixed monthly income during retirement.

Practice Question #3

Which of the following is NOT a type of defined contribution plan?

A) 403(b) Plan

B) Employee Stock Ownership Plan (ESOP)

C) Money Purchase Plan

D) Annuity

Select an option above to see an explanation here.

A) A 403(b) plan is a defined contribution plan for employees of non-profit organizations, such as schools and hospitals. B) An Employee Stock Ownership Plan (ESOP) is a defined contribution plan in which the employer contributes company stock to the employee's retirement account. C) A Money Purchase Plan is a defined contribution plan in which the employer contributes a fixed percentage of the employee's salary to the retirement account. D) An annuity is a financial product that provides a series of payments over time, often used for retirement income, and is not a defined contribution plan.

Historical Example

In the 1980s, many companies shifted from offering defined benefit pension plans to defined contribution plans, such as 401(k) plans. This change was driven by the desire to reduce pension plans' financial risk and long-term liabilities. The shift to defined contribution plans has placed more responsibility on employees to save and invest for their retirement.

Practice Question #4

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Example Series 65 Example Practice Question

Real-World Example

Jane works for a large corporation that offers a 401(k) plan. She contributes 6% of her salary to the plan, and her employer matches her contributions dollar-for-dollar up to 6%. Over time, Jane's account grows through her contributions, her employer's matching contributions, and the investment returns on her account. When Jane retires, she will have access to her 401(k) account funds to provide income during her retirement years.