Defined Contribution Plan
A defined contribution plan is an employer-sponsored retirement plan in which the employee, the employer, or both make contributions to individual accounts, with the eventual retirement benefit determined by the total amount accumulated and the performance of the investments chosen.
Unlike defined benefit plans, defined contribution plans shift investment risk and account management responsibility to the individual participant. The employer's obligation is limited to making contributions as specified by the plan document — there is no promise about the size of the eventual retirement benefit. The account balance at retirement depends entirely on the contributions made and the investment returns earned over time.
The most common defined contribution plans in the United States are 401(k) plans for private-sector employees, 403(b) plans for employees of public schools and nonprofits, and 457(b) plans for state and local government employees. Under all three, employees elect to contribute a percentage of their pre-tax wages through payroll deferrals, reducing current taxable income. Many employers match a portion of employee contributions — a common formula is 50 cents on every dollar up to 6% of pay — making the match an important component of total compensation.
IRS regulations impose annual limits on contributions. For 2024, the combined employee and employer contribution limit under IRC Section 415 is $69,000 (or 100% of compensation, whichever is less). The employee elective deferral limit under Section 402(g) is $23,000, with an additional $7,500 catch-up contribution permitted for participants aged 50 and older. The SECURE 2.0 Act of 2022 introduced a super catch-up provision beginning in 2025 that allows participants aged 60 through 63 to make even larger catch-up contributions.
Participants allocate their account balances among the investment options offered by the plan, typically a menu of mutual funds spanning asset classes such as domestic equities, international equities, bonds, and stable value funds. Target-date funds, which automatically shift to a more conservative allocation as the participant approaches retirement, have become one of the most widely used investment options in 401(k) plans and are frequently designated as the plan's qualified default investment alternative (QDIA).
At termination of employment, participants generally have the option to leave the account in the former employer's plan (if the balance exceeds $7,000 under SECURE 2.0 rules), roll it over to an IRA or a new employer's plan, or take a distribution subject to income tax and, if under age 59½, a 10% early withdrawal penalty. The portability of defined contribution accounts is one of their key advantages in an era of frequent job changes.