TECHNICAL GLOSSARY

Defined Contribution Plan: Understanding 401(k)s and Retirement Savings

A defined contribution plan is a retirement program where the employee and/or employer contributes money toward an individual account; however, unlike a defined benefit plan where the final amount of money received by the employee at retirement has already been established, the employee's final payout from a defined contribution plan will differ based on total contributions, performance of investments and any applicable fees. Defined contribution plans provide U.S. workers an opportunity to save for retirement while receiving a tax benefit from their contributions.

What Is a 401(k) Plan?

The most recognized example of a defined contribution plan is the 401(k). A 401(k) allows the employee and employer to contribute to an employee's 401(k) account; this is the retirement account where the employee's money is held for retirement. The 401(k) account is then invested by the financial advisor in financial instruments such as:

• Mutual funds
• Stocks
• Bonds

The actual retirement benefit (withdrawal amount) cannot be determined upfront. The amount available to withdraw or take in benefits is determined by:

• Total dollars contributed to the plan from both parties (employee and employer)
• Rate of return on your investments
• Management fees and other expenses incurred on a plan and its investments.

The contributions made by the employee to a traditional 401(k) are tax-deferred, reducing your tax liabilities in the year that you contribute. The value of your contributions and the investment gains generated by your contributions are tax-free until you take your withdrawn amount after retirement.

How Does a Defined Contribution Retirement Plan Work?

Additionally, contributions from both employees and employers into DCRP are made at regular intervals into each employee's individual retirement account, and returns on growth through investing will determine the amount of retirement income available to the employees of the plan at the time they retire. DCRP differs from traditional pension plans in that they do not guarantee a fixed benefit to retiree's from the plan but rather provide a flexible opportunity for retirees to take advantage of market investment returns as well as their total contributions into the plan through the use of a personal account designed specifically for each employee.

Common Types of Defined Contribution Plans

• 401(k) Plans: Employer-offered retirement savings plans and optional contributions by employees
• Individual Retirement Accounts (IRAs): Retirement saving accounts set up to allow individuals to save for retirement and receive tax advantages
• 403(b) Plans: Very similar to 401(k) plans except they are used by employees at non-profit organizations and at public schools

Benefits of Defined Contribution Plans

• Tax Advantages:
  Eligible Contributions May Decrease Taxable Income; Investment Earnings Accrue Tax-Deferred
• Control:
  Employees Determine the Investment Allocation of Their Contributions
• Portability:
  Employees May Roll Over Their Account Into a New Employer’s Plan or into an IRA.