Defined contribution investment only plans are a common type of employer-sponsored retirement plan. In these plans, employees contribute a portion of their salary into individual investment accounts. The key features of defined contribution investment only plans are:
– Employees choose how to invest their contributions from a menu of investment options offered by the plan. This gives employees control over their investments.
– Employer contributions are discretionary. The employer is not obligated to contribute.
– Employees bear the investment risks and rewards. Account balances depend on contributions and investment returns.
– Accounts are portable when changing jobs. Employees can roll over their account balance into a new employer’s plan or an IRA.
This article will further examine the defined contribution investment only plan type, its key attributes, and pros and cons for employees.
Employees Have Flexibility and Control Over Investments
A key advantage of defined contribution investment only plans is that employees get to choose how their contributions are invested. The plan sponsor selects a lineup of investment options, typically mutual funds, ETFs, and possibly company stock. Options usually include stock funds, bond funds, stable value funds, and target date funds. Employees select which funds to invest in and how to allocate their money. This gives employees control over their accounts based on individual risk tolerance and goals. However, it also means employees bear the investment risk. Those who make poor fund selections or time the market badly could end up with lower balances and less retirement income versus more optimal investment choices.
Accounts Are Portable When Changing Jobs
A major advantage of defined contribution plans is portability. When an employee leaves their job, they can roll over the account balance to a new employer’s plan or to an IRA. The account stays with the employee versus being tied to a particular employer. This supports retirement savings continuity when changing jobs, which is far more common nowadays than spending an entire career with one company. The defined benefit pension plans of the past did not offer this flexibility.
Tax-Deferred Savings and Potential Employer Match
Defined contribution investment only plans allow employees to make pre-tax contributions, lowering current taxable income. Earnings growth inside the account is also tax-deferred. Many employers will match a portion of employee contributions, such as 50% up to 6% of pay. This matched money provides a significant boost to retirement savings. However, the employer match is discretionary, not guaranteed as with defined benefit pension plans.
In summary, defined contribution investment only plans give employees control over investing while providing tax-deferred savings and potential employer matches. Accounts are also portable when changing jobs. However, employees assume all investment risk and results depend on the choices they make.