Life & Health Insurance Exam (National Portion)Life InsuranceMedium
A business owner wants to provide a retirement plan for their employees where contributions are made by the employer, but the ultimate benefit received by the employee is not guaranteed and depends on the performance of investments. Which type of plan does this describe?
- ADefined Contribution Plan
- BSimplified Employee Pension (SEP) Plan
- CNon-Qualified Deferred Compensation Plan
- DDefined Benefit Plan
Show answer & explanationAnswer & explanation
Correct answer: A. Defined Contribution Plan
A Defined Contribution Plan, such as a 401(k), specifies the amount of contributions made by the employer (and sometimes employee), but the final benefit depends on the investment performance of the plan assets. The employee bears the investment risk.
Why the other options are wrong
- B. A SEP is a type of defined contribution plan, but 'Defined Contribution Plan' is the broader and more accurate description of the mechanism outlined.
- C. Non-Qualified plans do not receive the same tax benefits as qualified plans and are typically for a select group of employees, not a general retirement plan as described.
- D. Defined Benefit Plans guarantee a specific benefit at retirement, with the employer bearing the investment risk.
Defined Contribution Plan
A type of qualified retirement plan where the employer (and sometimes employee) makes regular contributions, but the final retirement benefit is not guaranteed and depends on the investment performance of the account.
- Contributions are defined, not benefits.
- Employee bears the investment risk.
- Examples include 401(k)s, 403(b)s, and SEP IRAs.
- Account balance grows tax-deferred.
Memory trick: Retirement plans: define the BENEFIT or define the CONTRIBUTION.