Defined contribution pension plan - Financial definition
Concise definition of the term defined contribution pension plan
A defined contribution pension plan is a retirement plan where an employer, employee, or both make regular contributions to an individual account set up for the employee, with the future benefits depending on the investment performance of those contributions. The final amount available at retirement is not predetermined and depends on the contributions made and the returns on the invested funds.
Comprehensive definition of the term defined contribution pension plan
In a defined contribution pension plan, the contributions are typically invested in a variety of financial instruments such as stocks, bonds, and mutual funds, selected by the plan participant or a plan manager. The employee bears the investment risk, meaning that the retirement benefits will fluctuate based on the market performance of the chosen investments. Examples of defined contribution plans include 401(k) plans in the United States and Group Registered Retirement Savings Plans (RRSPs) in Canada.
These plans often offer tax advantages, such as deferred taxation on contributions and investment earnings until withdrawal. Unlike defined benefit plans, where retirement benefits are predetermined based on factors like salary and years of service, defined contribution plans provide flexibility and portability, allowing employees to take their savings with them if they change jobs. The shift from defined benefit to defined contribution plans reflects broader trends in employer-sponsored retirement savings, emphasizing individual responsibility for retirement planning and the impact of financial literacy on retirement outcomes.