Defined contribution plan

economic-dictionary

The defined contribution plan is a pension plan in which the company agrees to make monetary contributions each year for the benefit of the employee.

Generally, in a defined contribution plan the employee owns the right to the invested assets and is free to withdraw the accumulated funds if their withdrawal occurs prematurely. For this reason, it is said that defined contribution plans have portability, that is, if the employee ends his employment relationship with the company, he can transfer his funds to the pension plan of his new company or to a private pension plan.

Upon retirement, the employee can access accumulated funds, but unlike defined benefit plans, no amount is guaranteed. The investment risk is fully assumed by the employee.

For example, the company can contribute 1% of salary each month to a pension fund. The employee can also contribute part of his salary to this plan.

Types of contribution plans

Mainly we find the following two:

  • Direct defined contribution plan: The employee makes the investment decisions, that is, he is who decides where his money is invested.
  • Sponsored defined contribution plan: There is an intermediary who decides the investments.

In both cases, the employee is the one who assumes the risk.

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