Why is 401K Called a Defined Contribution Plan?

Is the 401k plan a ‘defined contribution’ plan? Does this mean I have to specify the contribution I make to the plan for my employees when I set up the plan?- Joyce Gallagher, Florida, runs a cake shop with 10 employees

The 401k plan is a defined contribution plan just like IRAs, Simple IRAs and SEPs. The amount that you contribute to this plan is defined either by you, the employer, or the employee or participant. This is why this retirement plan is termed a defined contribution plan.

But this does not mean that when you set up a 401K plan for your small business you are forced to make contributions to it irrespective of whether your business can afford it or not. There are many ways in which you can define your contribution. You can go for a profit sharing contribution which links your cake shop’s performance to your contributions. You can commit to a specific percentage match of your employee’s contribution as a means of encouraging participation. You can even entirely avoid outlining about your contributions in your 401K plan document at the time of set up if you want to have maximum freedom. When you do this, employer contributions, that is, contributions from your side become entirely discretionary.

It does make good business sense to stick to a regular employer contribution schedule though. Remember that you can claim deductions over your contributions and also get tax credits for funds going into this retirement plan.

If you have an existing plan but want to transform it into a more flexible one, you can find some excellent tools to do this quickly and painlessly at http://401k-network.com. This site has a comprehensive listing of the various online tools that can make setting up, managing and administering your 401k a breeze.

About Elliot Earl, Director, Pension Trade Association
Director, Pension Trade Association Founded in 1982, the Pension Trade Association [California Domestic Nonprofit Corporation #C1629080] is dedicated to helping workers save for their retirement through expanded coverage of 401k -type defined contribution pension plans.

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