Defined-Contribution Plan

What Is a Defined-Contribution Plan?

A defined-contribution plan is a type of retirement plan in which the amount going in is set by a formula or agreement, but the eventual payout is not guaranteed. The employee, the employer, or both contribute money to an individual account for each participant. The account's value rises or falls with the results of its investments. The most common example in the United States is the 401(k) plan.

How It Works

Each participant usually chooses how the money in the account is invested, often from a menu of mutual funds or other options. Contributions often come from paycheck deductions, and many employers add their own employer matching contribution as an incentive. Because the account belongs to the participant, the balance at retirement depends on how much was contributed, how the investments performed, and the fees charged along the way.

Some plans let the account move with a worker who changes jobs. Others require a waiting period before employer contributions fully belong to the employee. This rule is called vesting.

Advantages and Disadvantages

For investors, the appeal is flexibility and portability. Accounts can often be rolled into an individual retirement account (IRA) when someone leaves a job, and the worker keeps control over investment choices.

The trade-off is that investment risk sits with the participant rather than the employer. A weak market period can leave a balance well below expectations, and the plan does not promise a set income in retirement. Participants who contribute too little or invest carelessly may end up with less saved than they need.

Unlike a defined-benefit plan, which promises a specific retirement payment based on salary and years of service, a defined-contribution plan makes no such promise. Understanding this difference helps explain why these plans are so widely used in workplace retirement saving.