By Ian Berger, JD
IRA Analyst

You may know that you participate in a DC retirement plan. But what exactly does that mean? (Hint: It doesn’t mean that your plan is sponsored by the District of Columbia.)

“DC” actually stands for “defined contribution” plan. Defined contribution plans are a type of company retirement plan and are distinguished from DB (“defined benefit”) plans/

Types of DC plans. The most popular types of DC plans are 401(k) plans, 403(b) plans and 457(b) plans. Each of these types allows employees to make salary deferrals and may also allow employer contributions.

  • 401(k) plans are for employees of private sector companies. Thrift savings plans (TSPs) are similar to 401(k) plans and are for employees of the federal government and for the military.
  • 403(b) plans (also known as tax-sheltered annuity or TSA plans) are for employees of public schools, tax-exempt employers (e.g., hospitals) and churches.
  • 457(b) plans (also known as deferred compensation plans) are for employees of state and local governments. 457(b) plans are also available for certain management employees of tax-exempt employers.

Traditionally, DC plans only provided for employer contributions. Employer contribution-only plans include profit sharing plans, money purchase pension plans, stock bonus plans and employee stock option plans (ESOPs).

  • Profit sharing plans allow companies the flexibility to make whatever level of contribution (including no contribution) they wish to make each year.  (Despite the name, contributions don’t need to come out of company profits.) 401(k) plans sometimes include a profit sharing plan contribution.
  • Money purchase pension plans require the company to make a fixed amount of contribution each year.
  • Stock bonus plans are a type of profit sharing plan in which contributions are made in the form of company stock.
  • ESOPs are a type of stock bonus plan that provide special tax benefits to the company and plan participants.

Individual accounts. The main characteristic of a DC plan is that each participant has an individual account. Salary deferrals and employer contributions, along with investment earnings, are allocated to each account. Most DC plan sponsors offer a number of investments options (usually mutual funds) for participants to choose from.

Distributions. Many DC plans allow hardship withdrawals, loans or in-service distributions after age 59 ½. Payouts are also available upon severance from employment, disability and death. DC plans always offer payouts in the form of a lump sum distribution. Some plans also offer installments and/or annuity payment options.

Contribution limits. The tax code includes limits on DC contributions. Annual DC contributions (salary deferrals + employer contributions) to all accounts in plans maintained by one employer (and any related employer) can’t exceed a certain amount (for 2019, $56,000 or $62,000 if age 50 or older). In addition, annual salary deferrals to all plans can’t exceed a dollar limit (for 2019, $19,000 or $25,000 if age 50 or older).