How does a defined contribution plan determine retirement benefits?

A defined contribution plan determines retirement benefits based on the performance of investments. In this type of retirement plan, both the employee and, in some cases, the employer make contributions to the employee's individual account. The benefits received at retirement depend on how much has been contributed over the years and how well those investments have performed.

When contributions are made, they are typically invested in various assets such as stocks, bonds, or mutual funds. The retirement benefit grows over time based on the investment returns, which can fluctuate due to market conditions. Therefore, individuals holding accounts in defined contribution plans carry the investment risk, and their eventual benefits are tied to the success of their chosen investments over time.

In contrast, options that suggest fixed payments, employee longevity, or employer stock valuation do not accurately reflect how defined contribution plans operate. Such plans are not dictated by predetermined benefit formulas or company-specific stock assessments but are directly influenced by investment performance and the contributions made throughout the employee's tenure.