Defined Contribution Plan

A defined contribution plan is a workplace retirement account where the employee, the employer, or both make regular contributions. Unlike older pension plans, the final retirement benefit is not promised in advance. Instead, it depends on how much money goes in and how well the investments perform over time.

The most common examples of defined contribution plans include:

• 401(k) plans offered by private employers
• 403(b) plans for school and nonprofit employees
• 457(b) plans for government workers
• Thrift Savings Plans (TSP) for federal employees

Each participant has their own individual account. They typically choose from a menu of investment options such as mutual funds, index funds, or target-date funds. The account balance grows based on contributions and investment returns, and it can also shrink if investments lose value.

For 2026, the IRS allows employees to contribute up to $23,500 per year to a 401(k) or similar plan. Workers who are age 50 or older can make additional catch-up contributions of up to $7,500, bringing their total limit to $31,000. Employees between ages 60 and 63 have an even higher catch-up limit of $11,250 under rules introduced by the SECURE 2.0 Act.

Many employers also offer matching contributions. For example, a company might match 50 cents for every dollar an employee contributes, up to 6% of their salary. This employer match is essentially extra compensation that helps the account grow faster.

A practical example: Suppose someone earns $60,000 per year and contributes 6% of their salary, which equals $3,600. If their employer matches 50% of that amount, the employer adds $1,800. That means $5,400 total goes into the account that year before any investment growth.

One key difference from a traditional pension is that the employee takes on the investment risk. A pension promises a set monthly payment in retirement. A defined contribution plan offers no such promise. The balance at retirement depends entirely on contributions and market performance.

Withdrawals from most defined contribution plans are taxed as ordinary income in retirement. Early withdrawals before age 59 and a half may trigger a 10% penalty plus taxes.

RetireGrader is not a financial advisor or fiduciary. This definition is for educational purposes only.