Defined Contribution Pension Plan
Under a Defined Contribution Pension Plan (also called a “Money Purchase” Pension Plan), the contributions of plan members and plan sponsors are invested towards the funding of a retirement income. The maximum combined contribution is the lesser of 18% of earned income to the maximum contribution limit. Typically, the contribution going into the plan is known, while the final benefit is not known. The employer’s contributions are a tax deductible expense and are not a taxable benefit to the plan member.
Advantages of a Defined Contribution Pension Plan:
- Employee contributions by payroll deduction
- Easy to understand and communicate
- Employees can participate in investment decisions
- Actuarial calculations of funding not required
- Few problems with pensions surplus or over funding
- Contributions are tax deductible to the employer
- Contributions are not taxable to the plan member
- Employer costs are easier to predict (as compared to a Defined Benefit Pension Plan)
Disadvantages of a Defined Contribution Pension Plan:
- Benefit is not guaranteed
- Investment time is a crucial factor in determining benefit for older employees
- Benefit of older employees may be lower than under a Defined Benefit Pension Plan