Life & Health Insurance Exam (National Portion)Life InsuranceMedium
A business owner wants to set up a retirement plan that allows them to make contributions on behalf of their employees, but they want the investment risk to be borne entirely by the employees. Which type of qualified plan would be most suitable?
- ADefined Contribution Plan
- B403(b) Plan
- CDefined Benefit Plan
- DSimplified Employee Pension (SEP) IRA
Show answer & explanationAnswer & explanation
Correct answer: A. Defined Contribution Plan
In a Defined Contribution Plan, the employer contributes a defined amount, but the employee bears the investment risk, and the eventual benefit depends on investment performance. This aligns with the owner's desire for employees to bear the investment risk.
Why the other options are wrong
- B. A 403(b) Plan is a type of defined contribution plan, but it's specifically for public schools and certain tax-exempt organizations, not general businesses.
- C. In a Defined Benefit Plan, the employer bears the investment risk, guaranteeing a specific future benefit to the employee.
- D. A SEP IRA is a type of defined contribution plan, but the question asks for the general type of plan where employees bear the risk, not a specific variant.
Defined Contribution Plan
A retirement plan where the employer (and sometimes employee) contributes a specified amount, but the final retirement benefit depends on the investment performance of the contributions, with the employee bearing the investment risk.
- Employer contributes a set amount.
- Employee bears investment risk.
- Examples: 401(k), 403(b), Profit-Sharing, SEP IRA.
Memory trick: Contribution: EMPLOYEE takes the investment ride; Benefit: EMPLOYER guarantees the destination.