A defined contribution account is a retirement savings plan, such as a 401(k), where employees and/or employers contribute money to an individual account, with the retirement benefit depending on contributions and investment earnings.
Defined contribution (DC) plans are employer-sponsored retirement savings plans in which employees and/or employers contribute a set amount or percentage of wages into an individual account for the employee. The most familiar example in the United States is the 401(k) plan, though there are other versions such as 403(b) plans for nonprofit workers and 457 plans for government employees.
In a DC plan, the ultimate retirement benefit is not predetermined. Instead, the employee’s retirement income depends on the amount contributed, the performance of the investments chosen within the plan, and the length of time funds remain invested. This is a sharp contrast to defined benefit pensions, which provide a guaranteed lifetime payout based on factors such as years of service and salary history.
Employees usually contribute a portion of their paycheck to DC plans on a pre-tax basis. Many employers match contributions up to a certain level. The money grows tax-deferred in the plan until assets are withdrawn in retirement.
Importantly, individual savings-based defined contribution plans are far more efficient when workers start saving at younger ages. Those who start saving early benefit much more from the power of compound interest than those who don’t start saving until middle age or later. To illustrate the powerful impact of early saving, NIRS built this retirement calculator to demonstrate how much more can be saved for retirement when saving starts early.
Recent reforms to DC plans have included moving toward auto-enrollment to increase participation, normalizing target date investment options that automatically adjust as workers age, and keeping plan participants in the DC plan after retirement with fiduciary protections, and offering investment products that provide income in retirement.
These reforms aim at improving 401(k)s to be more user-friendly and pension-like and expanding access and participation. However, 401(k) plans have several drawbacks that favor higher income workers:
The tax incentives for these plans favor higher incomes, and half of all tax savings go to the top 10% of earners.
Higher paid workers are more likely to be offered a 401(k) plan by their employer and are more likely to participate in the plan.
Those with higher incomes can afford to save a larger share of their income.
This analysis finds that defined benefit (DB) pension plans offer substantial cost advantages over 401(k)-style defined contribution (DC) accounts. A typical pension has a 49 percent cost advantage as compared to a typical DC account, with the cost advantages stemming from longevity risk pooling, higher investment returns, and optimally balanced investment portfolios. A Better Bang […]
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This report documents how current tax incentives fail to promote adequate retirement security for the middle class. It considers the impact of factors including marginal tax rates, retirement plan participation, and income distribution on retirement saving levels. The Missing Middle: How Tax Incentives For Retirement Savings Leave Middle Class Families Behind also offers potential solutions […]
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This national opinion research finds 83% of Americans believe all workers should have a pension, 79% say the nation faces a retirement crisis, and they want action now on Social Security.
The Forgotten Generation: Generation X Approaches Retirement
Generation X often is referred to as the forgotten generation, sandwiched between the large and culturally powerful Baby Boomer and Millennial generations. Today, Generation X commands less attention than Boomers and Millennials from both researchers and the media. A groundbreaking new report aimed at correcting this oversight, at least in terms of assessing the retirement […]
