In a defined contribution plan, how are the benefits at retirement determined?

In a defined contribution plan, the benefits at retirement are determined by how contributions were invested. This means that the amount the employee receives upon retirement is directly tied to the total contributions made into the account throughout their working years and the investment performance of those contributions.

Contributions to the account typically come from both the employee and the employer. These contributions are invested in various asset classes, and the growth or decline in value of these investments directly affects the eventual retirement benefits. Unlike defined benefit plans that guarantee a specified payout at retirement based on a formula, defined contribution plans do not promise a predetermined benefit, making investment choices and their performance critical to determining the final value of the retirement account.

The other options do not apply to defined contribution plans. They generally describe characteristics of defined benefit plans. For instance, benefits calculated as a fixed dollar amount for each year of service or using a formula involving average earnings are specific to defined benefit plans, where the employer assumes the investment risk and guarantees a particular payout. Similarly, benefits based solely on the employer's years of service do not reflect the nature of defined contribution plans, where the emphasis is on individual account performance rather than tenure.