Under a defined contribution plan, the contribution that the company will make to the plan and how the contribution will be allocated among the eligible employees is defined. Individual account balances are maintained for each employee. The employee’s account grows through employer contributions, investment earnings and, in some cases, forfeitures (amounts from the non-vested accounts of terminated participants). Some plans may also permit employees to make contributions on a before-and/or after-tax basis.
Since the contributions, investment results and forfeiture allocations vary year by year, the future retirement benefit cannot be predicted. The employee’s retirement, death or disability benefit is based upon the amount in his or her account at the time the distribution is payable.
Employer account balances may be subject to a vesting schedule. Non-vested account balances forfeited by former employees can be used to reduce employer contributions or be reallocated to active participants.
Tax deduction limits must also be taken into consideration. Employer contributions cannot exceed 25% of the total compensation of all eligible employees.