9.4 Defined Contribution Plans
Defined contribution plans address the funds that are literally deposited into the employee account. A predetermined amount is contributed and grows over a period of time with timely contributions, interest and earned dividends. Defined contribution plans can be further divided into three different types.
- Profit sharing plans
- Stock bonus plans
- Money-purchase plans
Profit Sharing Plans
Profit sharing plans allow employees to participate in the company's profits through a plan formula established and maintained by the employer. It is not necessary for the employer to make yearly contributions; however, in order to qualify for favorable tax treatment by the IRS, the plan must be maintained with recurring and substantial contributions.
Stock Bonus Plans
Stock bonus plans are similar to profit sharing plans except that benefits are delivered in the form of company stock instead of relying on the profits of the company.
Money-Purchase Plans
Money-purchase plans depend on fixed contributions and are better suited to the true definition of defined contribution plans. Contributions and earnings adhere to a definite formula, distributions are made only in accordance with amounts credited to participants, and accounts are adjusted according to annual valuations.
A defined contribution plan is a tax qualified retirement plan in which annual contributions are determined by a formula set forth in the plan. Benefits paid vary with the amount of contributions made and length of service.
