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Defined Contribution Plan

Definition

In the United States, this form of retirement plan is often known simply as a 401(k) plan to most people. So if you hear this term or "DC Plan" thrown around, just remember that this is really just your 401(k). A defined contribution plan allows the employee to save a certain percentage of their pre-tax pay for each year (the allowable amount you can contribute increases every year according to IRS tables) in an investment account. Many employers in the U.S. have unfortunately abandoned the Defined Benefit Pension Plan in favor of these DC Plans. The primary reason is because DC Plans are much cheaper for the company (they normally just match a small percentage of your contributions) and perhaps best of all, the company sheds a major liability (namely, having to pay you monthly annuity installments for many years after you have left the firm).

Using the term Defined Contribution Plan :

When you do finally retire under a DC Plan, you will often take your distribution in a lump sum payment. However, you often have numerous options. These might be to take a lump sum payment or receive annual installments or an option particular to your plan.

Pay Special Attention To :

The primary risks to be aware of are: 1) The way the defined contribution plan is invested in usually up entirely to you, not the company (remember what we said above about them shedding their liability?). So you are responsible for whatever amount is in the account when you retire. It is based on your investment choices. 2) Do be aware that when you choose either a lump sum payment or annual installments, it is a one time decision. So get professional advice from an accountant if you are unsure of what to choose.

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Related terms

Defined Benefit Pension Plan