J.G. Gaston & Associates, Inc.
Actuarial Consulting Services for Business, Government, and the Individual

Defined Contribution Plans

Description

Defined Contribution Plans provide for a fixed or discretionary contribution to an account balance maintained on behalf of each employee. Plans with a 401(k) employee savings feature allow employees to contribute a portion of their compensation to the plan. Some employers match employee 401(k) contributions. The ultimate retirement benefit is based upon the periodic distributions which can be provided by the accumulated account balance upon retirement.


Account Balance Accumulation
Year Compensation Contribution Invest Income Ending Balance
2004 29,000 870 0 870
2005 30,000 900 44 1,814
2006 31,000 930 91 2,835
2007 32,000 960 142 3,937
2008 33,000 990 197 5,124
2009 34,000 1,020 256 6,400
2010 35,000 1,050 320 7,770
2011 36,000 1,080 389 9,239
2012 37,000 1,110 462 10,811
2013 38,000 1,140 541 12,492

An example of a defined contribution plan is as follows:


Annual compensation: Ranges from $29,000 to $38,000


Years of service at age 65 retirement: 10 years


Contribution formula: 3.0% of an employee's compensation


Investment income net of fees: 5.0% per annum



Approximate benefit which can be provided at age 65: $98¹ per month


Illustration

The following is an illustration of contributions to a very basic defined contribution plan with a Social Security integrated formula providing 5.7% of compensation, plus 5.7% of compensation above the Social Security wage base ($113,700 for 2013).



 
Employee Age

Annual

Compensation

Rate

Base Employer Contribution

Integrated Employer Contribution

Total

Annual

Contribution

Principal 40 255,000 14,535 8,054 22,589
Sub-total   255,000     22,589
Staff1 35 45,000 2,565 0 2,565
Staff2 30 40,000 2,280 0 2,280
Staff3 25 35,000 1,995 0 1,995
Sub-total   130,000     6,840
Grand Total   385,000     29,429
Ratio of Pirincipal to Employee        
3.3 to 1


With only small additional complexity and expense, this employer could consider a Safe Harbor 401(k) Profit Sharing Plan which would allow the principal to contribute an additional $17,500 per year as an employee contriubtion and would allow his or her employees to do the same.



¹ Based on Group Annuity 1983 Unisex Mortality and 6.00% per annum interest.