What characterizes a defined contribution pension plan?

A defined contribution pension plan is characterized by the way retirement benefits are accumulated through individual accounts, where contributions made by both the employee and employer are invested on behalf of the individual. The final benefits received at retirement depend not only on the total contributions made over the years but also on the investment performance of those contributions.

In this setup, each employee has their own dedicated account, and the responsibility of managing the investments typically falls to the individual, although employers may offer a range of investment options and guidance. Unlike defined benefit plans, which promise a specific payout at retirement based on factors such as salary history and duration of employment, defined contribution plans do not guarantee a fixed benefit amount.

The features of defined contribution plans make them appealing to employers because they can limit their financial obligation, as they are not required to provide a specific retirement benefit. Rather, they contribute a set amount to the individual's account, and the risk of investment performance falls on the employee.

Thus, the correct understanding of a defined contribution pension plan reflects its individual and contributory nature, which is fundamentally different from other plan types that may be managed collectively or guaranteed by an entity.