Defined-Contribution Plans

Employers have become less generous than they had been in the past with pension benefits. Corporate restructurings have left many people working for smaller businesses which usually don't offer generous pensions. Many big established companies have changed from, or rely less on, the more costly defined-benefit plans. Instead, many companies now use the less expensive and more flexible defined-contribution plans.

Defined contribution plans are actually a broad range of programs including profit-sharing plans, money-purchase plans, 401(k) plans, employee stock ownership (ESOP) plans and others. Either you alone, or you and your employer make contributions into the plan, usually based on a percentage of your annual earnings. Each participant has an individual, separate account. There is no way to determine in advance what the final payout at retirement will be. Your benefits depend on how much was contributed in your name and how well the pension fund investments performed. So, the risk of fluctuations in investment return is shifted to the employees. The government sets a limit on how much can be contributed in your name each year no matter how many different plans you participate in. The total amount that can be contributed in one employee's name for 2002 is the lesser of $40,000 ($35,000 for 2001) or 100 percent of the employee's annual earnings (25 percent for 2001). The contributions are allocated to separate accounts for each participant based on a definite, predetermined formula. Forfeitures can be reallocated to remaining participants.

Other examples of defined contribution plans for small businesses to consider include: