A Defined Contribution Plan is a type of retirement plan in which the employer, employee, or both make regular contributions, and the future benefits of the plan are not guaranteed. The value of the plan is dependent on the amount of money contributed and the performance of the investments.
The most common examples of defined contribution plans include 401(k) plans, 403(b) plans, employee stock ownership plans, and profit-sharing plans in the United States.
In a Defined Contribution Plan, the risk and reward associated with the plan’s investments are typically managed by the employee, not the employer. This means the retirement income depends on the investment’s performance, and if the investments do not perform well, the employee may end up with less money than expected for retirement.
Contrast this with a Defined Benefit Plan, where the employer guarantees a specific retirement benefit amount to the employee based on a set formula, often involving the employee’s salary, years of service, and age. In a Defined Benefit Plan, the employer bears the investment risk.