There are several variations of defined contribution plans. A few of the more common ones include:
1. Money Purchase Pension Plans: The employer contributes a specified fixed percentage of each participant's annual salary to the plan each year, to a maximum of 25% of compensation. Contributions to a Money Purchase Pension Plan are not based on employer profits, therefore contributions must be made regardless of whether the company is profitable. With the passage of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), money purchase plans have become obsolete and many are being converted to profit sharing plans.
2. Traditional Profit Sharing Plans: The employer contributes a discretionary percentage of each participant's annual salary to the plan, to a plan maximum of 100% of compensation. In a profit sharing plan, the contribution level is selected by the plan trustee(s) each year. Annual contributions are not required, provided that contributions are made on a substantial and recurring basis, as defined by the Internal Revenue Service.
3. New Comparability (Cross-Tested) Profit Sharing Plans: Employer contributions are allocated by percentage to nondiscriminatory classification groups stated in the plan (e.g. owners, all other employees.) Each classification group receives a percentage of the employer contribution, usually with one classification group receiving a higher percentage than the other classification groups. The plan must pass nondiscrimination testing to ensure that non-highly paid employees are receiving an equitable contribution in comparison to the highly paid employees.
4. 401(k) Profit Sharing Plans: Some profit sharing plans have a 401(k) feature that allows eligible participants to defer a portion of their compensation into a retirement account. The money is contributed to the 401(k) plan on behalf of the participant instead of being paid as taxable compensation. In addition to the employee elective deferrals (also called salary deferrals), the employer may make profit sharing contributions to the plan according to the formula specified. The employer may also choose to make a matching contribution to the plan to reward employees who are deferring income to the 401(k) portion of the plan.
5. Safe Harbor 401(k) Profit Sharing Plans: A 401(k) profit sharing plan may also have a safe harbor feature. This plan provision requires the employer to contribute a minimum of three percent of compensation to all employees or to provide a 100 percent match of the first three percent of compensation plus 50 percent of the next two percent of compensation for employees who defer. Both types of safe harbor contributions are immediately 100 percent vested. When a safe harbor contribution is made and appropriate notice is provided to eligible participants, the discrimination testing for salary deferrals is deemed to pass, effectively allowing the highly paid employees to defer up to the individual salary reduction maximum.