Defined-Contribution PensionsIn the simplest defined-contribution plan, the employer contributes a fixed percentage of each employee's salary to the pension trust fund. Those plans are considered true pensions, and unlike other types of defined-contribution plans, offer little to customize other than the formula for determining contributions. They are almost always classified as money purchase plans (although some are classified as target benefit plans). A pension trust fund is invested by the plan's administrators and accumulates earnings throughout an employee's tenure with a firm. At retirement, the participant receives his or her share of the fund either in a lump sum or as an annuity. Early withdrawals and loans are rarely permitted. Employers can determine their percentage of contribution in different ways. Some plans simply apply a uniform percentage to the earnings of all employees. Other plans integrate contributions with Social Security by contributing a higher percentage for employees who have salaries that exceed the maximum taxable Social Security wage base. Target benefit plans explicitly derive percentage contributions by actuarially calculating the cost of a target pension replacement rate that is selected by the employer. That rate is not guaranteed, however. Despite their simplicity, money purchase and target benefit plans have not been widely used in recent years. Only 10 percent of employees of state and local governments (in 1998), 5 percent of employees of medium-sized and large establishments (in 2002), and 2 percent of employees of small establishments (also in 2002) participated in such plans. Prior to the passage of EGTRRA, employers could deduct a higher percentage of compensation as contributions to pensions (25 percent) than the percentage they could deduct for contributions to profit-sharing plans (15 percent). EGTRRA eliminated that differential, making money purchase and target benefit plans less attractive to employers relative to profit-sharing plans. As a result, money purchase and target benefit plans are expected to largely disappear in the near future.
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