Sources of Contributions

Different types of plans rely on different sources for their funding. Defined-benefit plans, for example, rely much less heavily on employee contributions than do defined-contribution plans. One important difference between the two sources is that employees' contributions are subject to Social Security and Medicare taxes, whereas those of employers are not.(1)

Defined-Benefit Plans

Most private defined-benefit plans are funded solely by employers' contributions. Indeed, 95 percent of private-sector employees who are eligible for coverage make no direct contributions to their plans. By contrast, employees of the federal government and of nearly all the states are required to contribute, and in many cases, their contributions are not tax-deferred. Mandatory contributions may be more common for public employees because historically, most of them did not contribute to Social Security. Their pensions served as a substitute, and their contributions acted as a parallel substitute for the payroll tax. Employees in the public sector now commonly participate in Social Security, and some employees' contributions are tax-deferred. However, the way pension contributions are structured has changed relatively little. Contributions by employees generally cover well below half of the costs of public-sector retirement plans, with employers making up the difference.

Defined-Contribution Plans

The sources of contributions to defined-contribution plans vary with the type of plan. Money purchase plans are generally funded solely by employers, although some plans allow employees to contribute. Employers also primarily fund profit-sharing plans that are not 401(k) plans, although approximately one-quarter of participating employees have the option of contributing. By contrast, employees always contribute to 401(k) plans, with employers matching at least part of those contributions in most plans; overall, about 30 percent of participating employees receive no matching contributions. Section 403(b) plans are also funded through a combination of contributions by employees and employer matches. Employer contributions to 457 plans, however, count against the dollar limit on employee contributions and hence are rare.

1.  The distinction between employer and employee contributions is important in applying the law but is somewhat artificial from an economic standpoint. According to economic theory, contributions made by employers correspondingly reduce wages or other benefits, so despite their label, they are actually contributed indirectly by employees.

 
Sources:  Bureau of Labor Statistics, National Compensation Survey: Employee Benefits in Private Industry in the United States, March 2005, p. 27.

Bureau of Labor Statistics, National Compensation Survey: Employee Benefits in Private Industry in the United States, 2002-2003, pp. 5-108.

Bureau of Labor Statistics, Employee Benefits in State and Local Governments in 1998, pp. 5 and 104.

Bureau of Labor Statistics, Employee Benefits in Medium and Large Private Establishments in 1997, p. 132.