A defined contribution plan allows the employer to contribute annually a percentage of the compensation of the participants. In one defined contribution plan, a profit sharing plan, the employer can contribute annually between 0 and 25% of total eligible compensation. An advantage of this type of plan is in the flexibility of contributions allowed. In another defined contribution plan, a money purchase pension plan, the employer MUST contribute annually a fixed percentage (between 0 and 25% but not exceeding $44,000 in 2006, adjusted annually) of each eligible participant's compensation. An advantage of this type of plan is that it allows greater contributions than a profit sharing plan. A 401(k) Plan is a popular type of profit sharing plan. It encourages employees to make their own contributions to the plan, thus enabling employers to their costs.
A defined benefit plan is designed to provide a desired retirement benefit for each participant. The contributions to provide these benefits are actuarially determined annually. This type of plan allows for larger contributions for older employees.