Text Box: A LESSON IN QUALIFIED RETIRMENT PLANS The information contained in these page focuses on pension benefit plans under the Employee Retirement Income Security Act of 1974 (ERISA), particularly those plans considered qualified for special tax considerations under the Internal Revenue Code. These plans are commonly referred to as “qualified plans.” Defined Contribution Plans A defined contribution plan allocates contributions to a participant’s account in the plan. These plans are also known as individual account plans and define the contributions a participant receives under the plan. For example, a plan may provide that each participant will receive an allocation equal to 5 percent of his or her compensation. These contributions are allocated to individual accounts maintained for each participant within the plan. The accumulated value of the participant’s account at retirement or termination of employment is the participant’s total retirement benefit from the plan. The participant bears the investment risk in a defined contribution plan. There is no guaranteed amount paid to the participant at retirement. The employer contributions are the extent of the employer’s commitment to the participant’s retirement income. Investment results are not guaranteed and do not affect the employer’s cost. Employees readily understand a defined contribution plan. It is easy to see how much has been added to their accounts each year. The participant receives a statement of his or her individual account that displays his or her share of contributions and plan earnings (or losses). Since a defined contribution plan operates similar to a savings account, the participant understands the real dollar value of his or her retirement benefits under the plan. Younger employees find the defined contribution plan more attractive primarily because a young participant generally receives a greater benefit from the compounding effect on employer contributions in a defined contribution plan. Consider the situation in which an employer contributes $500 per year to each employee’s account. An employee who begins working for the company at age 25 will accumulate a much larger account by retirement than an employee who begins working for the company at age 50. Assuming a young participant does not remain with the same employer for his or her entire working lifetime, he or she stands to accumulate a larger vested interest in a defined contribution plan than in a defined benefit plan for the same period of employment. This is due to the differences in benefit accrual rates under a defined contribution plan when compared to a defined benefit plan. There are limitations on the amount of contributions that can be allocated to participant accounts annually.¨
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