defined contribution plan
A retirement plan in which employees and employers contribute defined amounts, with the final benefit depending on investment performance rather than a guaranteed payout.
Example
“Unlike a pension, his defined contribution plan meant retirement income depended entirely on how his investments performed.”
Memory Tip
Defined CONTRIBUTION = the CONTRIBUTION (input) is defined. Your retirement depends on investment returns.
Why It Matters
Understanding defined contribution plans is crucial because your retirement security depends on how much you and your employer contribute plus investment returns, not a guaranteed income. This means you bear the investment risk and must actively manage your retirement savings through smart contribution rates and investment choices.
Common Misconception
Many people mistakenly believe that defined contribution plans guarantee a specific monthly retirement income like pensions do. In reality, the final amount you receive depends entirely on how much was contributed and how well those investments performed over time, which can vary significantly.
In Practice
Suppose you contribute 6 percent of your $50,000 salary to a 401(k) plan while your employer matches 3 percent. That is $3,000 from you and $1,500 from your employer annually. If these contributions earn an average 7 percent return over 30 years, your account could grow to approximately $650,000, but if markets perform poorly, the balance could be considerably lower.
Etymology
DEFINED (specified) CONTRIBUTION (amount put in). The CONTRIBUTION is DEFINED, not the benefit.
Common Misspellings
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Related Terms
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See Also
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