Defined Contribution Plans
A defined contribution plan defines the contribution the company will make to the plan and
how the contribution will be allocated among the eligible employees. Separate account
balances are maintained for each employee. The employee's account grows through employer
contributions, investment earnings and, in some cases, forfeitures (amounts from the
non-vested accounts of terminated participants). Some plans may also permit employees to
make contributions on a before-and/or after-tax basis.
Since the contributions, investment results and forfeiture allocations vary year by year, the
future retirement benefit cannot be predicted. The employee's retirement, death or disability
benefit is based upon the amount in his account at the time the distribution is payable.
Employer account balances may be subject to a vesting schedule. Non-vested account
balances forfeited by terminating employees can be used to reduce employer contributions or
be reallocated to active participants.
The maximum annual amount that may be credited to an employee's account (taking into
consideration all defined contribution plans sponsored by the employer) is limited to the lesser
of 100% of compensation or $44,000 for 2006 and $45,000 for 2007.
The maximum employer tax deduction limit must also be taken into consideration. Employer
contributions cannot exceed 25% of the total compensation of all eligible employees. For
example, a company with only one employee earning $100,000 in 2006 would have a maximum
deductible employer contribution of $25,000 (25% of $100,000). However, the employee could
also make a $15,000 401(k) contribution to the plan. As a result the total amount credited to
his account for the year would be $40,000 (40% of his compensation), and he would satisfy
the 2006 maximum annual limit since total contributions are less than $44,000.
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