Did you know that offering a defined contribution plan can reduce employee turnover by up to 72%? This powerful retention tool isn’t just good for employees—it’s essential for employers who want to attract and keep top talent in today’s competitive market.
Selecting the right retirement plans for your organization, however, can feel like navigating a complex maze. With numerous options available—from 401(k)s to SIMPLE IRAs to profit-sharing arrangements—each with different contribution limits, administrative requirements, and compliance considerations, making the optimal choice requires careful analysis.
What works for a small startup will certainly differ from what benefits a mid-sized manufacturing company or a large corporation. Your company size, budget constraints, and workforce demographics all play crucial roles in determining which plan will serve your business objectives while providing meaningful benefits to employees.
This step-by-step guide will walk you through the process of selecting the perfect defined contribution plan for your organization. We’ll break down the different types of plans, explain key factors to consider, outline your legal responsibilities, and provide a clear roadmap for implementation. By the end, you’ll have the knowledge and confidence to make an informed decision that balances your company’s financial goals with your employees’ retirement needs.
Understanding Defined Contribution Plans
Defined contribution plans represent a fundamental shift in how retirement benefits are structured. Unlike their predecessors, these plans establish individual accounts for participants where contributions grow based on investment performance rather than promising specific retirement benefits 1.
Understanding Defined Contribution Plans
In a defined contribution plan, both employers and employees can make regular contributions to individual retirement accounts. The defining characteristic is that these plans specify the contribution amount—not the final benefit. Furthermore, the ultimate retirement payout depends entirely on how much was contributed and how well those investments performed over time 2.
What makes them different from defined benefit plans
The fundamental distinction between defined contribution and defined benefit plans lies in who bears the investment risk. In defined contribution plans:
- The employee assumes all investment risk and reward 3
- No guaranteed retirement amount exists 1
- Benefits fluctuate based on market performance 4
- Employees typically control investment decisions 3
In contrast, defined benefit plans (traditional pensions) guarantee specific retirement payments, with employers bearing the investment risk. According to the Congressional Research Service, despite 68% of workers having access to either type of retirement plan in 2021, only 15% had access to defined benefit plans 5. Meanwhile, defined contribution plans accounted for $10.6 trillion of the $38.4 trillion in total retirement plan assets held in the United States as of December 31, 2023 1.
Another key difference involves tax treatment. Defined contribution plans accept pre-tax dollars and allow investments to grow tax-deferred until withdrawal at retirement age (minimum 59½ years). This structure benefits employees who typically earn more during working years than in retirement, potentially placing them in lower tax brackets when withdrawing funds 1.
Why employers prefer defined contribution plans
The dramatic shift from defined benefit to defined contribution plans reflects several employer advantages:
First, administrative costs are substantially lower for defined contribution plans. Additionally, these plans shift liability from employers to employees, removing the risk of underfunded pension obligations from company balance sheets 5.
For employers, the defined contribution approach offers predictable costs and eliminates the long-term financial obligations that come with pension promises. As workplaces evolve, these plans also provide portability for increasingly mobile workforces—employees can take their retirement savings when changing jobs 2.
The trend toward defined contribution plans is unmistakable. In the UK, many large defined benefit plans no longer accept new employees 3. In the US, private sector companies have overwhelmingly embraced the defined contribution model, transferring retirement planning responsibility to individual workers 5.
Despite their popularity, defined contribution plans require careful consideration. Without the safety net of guaranteed benefits, employees must actively manage their investments to ensure adequate retirement funding. Moreover, early withdrawals before age 59½ typically incur a 10% penalty unless exceptions apply 1.
Types of Defined Contribution Plans
Employers looking to establish retirement benefits face several defined contribution plan options, each with distinctive features tailored to different business needs. Understanding these variations helps in selecting the most appropriate plan for your organization.
Types of Defined Contribution Plans
401(k) and Roth 401(k) Plans
The 401(k) plan stands as the most recognized defined contribution option, allowing employees to make pre-tax salary reduction contributions. These contributions grow tax-deferred until withdrawal, typically reducing current taxable income. The annual contribution limit for employees is $23,500 in 2025, with those 50 and older eligible for an additional $7,500 catch-up contribution 67.
In contrast, Roth 401(k) plans accept after-tax contributions while offering tax-free qualified withdrawals in retirement. This option particularly benefits employees who anticipate being in a higher tax bracket during retirement. Notably, employers can offer both traditional and Roth 401(k) options simultaneously, allowing employees to split contributions between accounts as long as total contributions remain within annual limits 78.
SIMPLE IRA Plans
Small businesses with 100 or fewer employees can establish Savings Incentive Match Plans for Employees (SIMPLE IRAs). These plans require minimal paperwork and eliminate the need for annual testing requirements that accompany 401(k) plans 9.
Employers must contribute through either a matching contribution (up to 3% of compensation) or a 2% nonelective contribution for all eligible employees regardless of their participation 9. For 2024, employees may defer up to $16,000, with those 50 and older permitted an additional $3,500 catch-up contribution 9.
SEP IRA Plans
Simplified Employee Pension (SEP) IRAs offer an uncomplicated retirement solution for businesses of any size, including self-employed individuals. Only employers contribute to these plans—up to 25% of each employee’s compensation or $69,000 for 2024, whichever is less 1011.
SEP plans provide exceptional flexibility, allowing employers to adjust contribution amounts annually or even skip contributions entirely during challenging financial years 10. Nevertheless, when contributions are made, employers must contribute the same percentage for all eligible employees 11.
Profit-Sharing Plans
Profit-sharing plans give employers complete discretion over annual contributions. Unlike other plans, businesses don’t need to generate actual profits to contribute—they simply need a set formula for allocating contributions among participants 12.
Most companies utilize the “comp-to-comp” method, which allocates contributions proportionally based on employee compensation 12. Annual contribution limits match those of other defined contribution plans—the lesser of 100% of compensation or $69,000 for 2024 12.
Employee Stock Ownership Plans (ESOPs)
ESOPs represent a unique category of defined contribution plans primarily invested in employer stock. These plans create a trust fund where companies contribute new shares or cash to purchase existing shares 13.
Beyond retirement benefits, ESOPs offer significant tax advantages. Companies can deduct contributions used to repay ESOP loans, and in C corporations, once the ESOP owns 30% of company shares, sellers can defer taxes on gains by reinvesting proceeds 13.
Employees must be 100% vested within three to six years and receive their stock allocation when leaving the company, with the company required to buy back shares at fair market value 13. While powerful tools for business succession and employee ownership, ESOPs involve substantial setup costs ($125,000 to $500,000) and require regular valuation of company shares 13.
Key Factors to Consider as an Employer
Selecting the optimal defined contribution plan requires careful analysis of several organizational factors. Your company’s specific characteristics will significantly influence which plan will best serve both your business objectives and employees’ retirement needs.
Company size and workforce structure
Company size dramatically impacts retirement plan adoption rates. According to the U.S. Bureau of Labor Statistics, only 57% of private-sector firms with fewer than 100 workers offered retirement benefits in 2023, compared to 86% of companies with 100 or more workers 5. This gap widens further with 91% of firms with 500+ employees providing retirement benefits 5.
Size affects not just adoption rates but also costs. Small-business employers typically incur higher fees for sponsoring retirement plans than larger firms, which can spread fixed costs across more participants and a larger asset base 5. Consequently, smaller plans have less bargaining power with providers because they offer fewer investment assets for management.
Budget and contribution flexibility
Cost concerns represent the primary barrier to plan adoption—37% of small employers cite cost as the main reason for not offering a plan 5. Yet many small businesses overestimate the financial commitment required. One survey found that over half of small firms believed offering a retirement plan would cost more than $10,000 annually, with nearly 30% estimating costs exceeding $20,000 per year 5.
In reality, cost-effective options exist specifically for smaller employers. Additionally, federal tax incentives can offset expenses—eligible employers with 100 or fewer employees may claim tax credits up to $5,000 for starting a new plan in each of the first three years 5.
Employee participation and eligibility
Although offering and participation rates differ substantially by firm size, take-up rates (employees joining when plans are offered) remain remarkably consistent across organizations. Approximately 80% of employees participate when offered a plan, regardless of company size 14. This indicates employees value retirement benefits equally across different sized organizations.
Participation rates vary significantly based on:
- Income level (63% participation for management/professional workers vs. 19% for service workers) 15
- Full-time vs. part-time status (66% vs. 24% participation respectively) 16
- Industry type (manufacturing firms typically show higher participation than service industries)
Administrative complexity
Administrative burden represents the second most common reason (22%) employers cite for not providing retirement plans 5. Compliance costs include annual Form 5500 preparation ($250-$750) and plan restatements for regulatory updates (approximately $1,500) 5.
Specifically, employers with defined contribution plans must provide participants with annual information about plan details, potential administrative costs, and comparative investment option information 5. These requirements grow more complex as company size increases.
Therefore, when evaluating potential plans, consider not just current needs but also how administrative requirements might evolve as your organization grows. Many employers find that the retention benefits ultimately outweigh administrative investments, especially given the finding that 89% of firms offering plans agree they help hire and retain workers 5.
Compliance and Legal Responsibilities
Administering a defined contribution plan comes with significant legal obligations that employers must understand and fulfill. The federal government has established comprehensive regulatory frameworks to protect retirement plan participants.
ERISA and fiduciary duties
The Employee Retirement Income Security Act of 1974 (ERISA) establishes protections for retirement plan participants by setting minimum standards for most voluntarily established private-sector retirement plans 17. Under ERISA, plan fiduciaries—anyone who exercises discretionary authority over plan management or assets—must uphold specific responsibilities 18:
- Act solely in the interest of plan participants and beneficiaries
- Carry out duties with prudence, skill, and diligence
- Follow plan documents precisely
- Diversify plan investments to minimize risk
- Pay only reasonable plan expenses
Notably, fiduciaries who breach these duties may be personally liable for restoring losses to the plan 17. This accountability emphasizes the need for fiduciaries to document their decision-making processes and, when lacking expertise, to hire qualified professionals 19.
Reporting and disclosure requirements
Plan administrators must regularly file reports and provide notices to both government agencies and plan participants. The primary reporting obligation is Form 5500, an annual return filed with the IRS, Department of Labor, and in some cases, the Pension Benefit Guaranty Corporation 20.
In addition to government filings, administrators must provide participants with:
- Summary Plan Description (SPD) explaining key plan features
- Summary Annual Report (SAR) summarizing the Form 5500
- Annual funding notices (for defined benefit plans)
- Notifications of benefit determinations
These disclosures must be accessible—plan administrators can provide them on paper or electronically, provided they meet regulatory requirements for electronic delivery 21.
Contribution limits and nondiscrimination rules
The IRS establishes annual contribution limits that increase periodically with inflation. For 2025, defined contribution plans have an overall limit of $70,000 per participant 1. The employee elective deferral limit for 401(k) plans stands at $23,500, with an additional $7,500 available for participants age 50 and older 3.
Essentially, defined contribution plans must pass annual nondiscrimination tests to ensure they don’t disproportionately benefit highly compensated employees (HCEs) or key employees 2. These tests include:
- Coverage tests to confirm the plan benefits enough non-HCEs
- Actual Deferral Percentage (ADP) test comparing HCE and non-HCE deferral rates
- Actual Contribution Percentage (ACP) test for matching contributions
- Top-heavy testing when key employee accounts exceed 60% of plan assets
Failed tests require corrective action—typically refunding excess contributions to HCEs or making additional contributions to non-HCEs—by March 15th of the following year to avoid excise taxes 4.
Step-by-Step Guide to Choosing the Right Plan
Choosing the ideal defined contribution plan requires a methodical approach that aligns with your organization’s unique needs and objectives. First and foremost, understanding each step in the selection process helps ensure you make informed decisions that benefit both your business and employees.
Step 1: Define your business goals
Begin by clearly articulating what you want to achieve with your retirement plan. Consider whether you’re primarily focused on tax advantages, attracting talent, or maximizing owner benefits. Your relationship manager should consult with you about your company’s goals and employee demographics to design a plan that fits your specific situation. This initial assessment sets the foundation for all subsequent decisions.
Step 2: Evaluate plan types against your needs
Once you’ve established your objectives, assess each plan type against your requirements. Consider these key factors:
- Business structure (solo operation vs. employees)
- Contribution flexibility needs
- Administrative complexity tolerance
- Tax treatment preferences
- Employee demographics and participation goals
This evaluation helps narrow your options to plans that best align with your organization’s specific circumstances.
Step 3: Consult with a financial advisor or plan provider
Subsequently, engage with retirement plan specialists who can provide detailed analysis of your options. These experts will conduct a comprehensive assessment of available providers, plan fees, investment options, and administrative support. Their expertise helps ensure you select a plan offering the best value while meeting your organization’s requirements.
Step 4: Set up and communicate the plan to employees
After selecting a plan, develop a robust communication strategy. This might include webcasts, letters, emails, or a combination of methods. Effective education dramatically improves participation rates—some organizations report participation rates exceeding 95% with proper communication strategies. Short, targeted videos under two minutes particularly succeed in engaging employees.
Step 5: Monitor and adjust the plan over time
In effect, plan selection is not a one-time decision. Establish a regular review schedule to monitor provider performance, investment lineup, and fee structures. Annual evaluations ensure your plan remains competitive and compliant. Consider conducting a request for proposal (RFP) every three to five years to reassess market offerings and validate your current arrangement.
Conclusion
Choosing the right defined contribution plan represents a critical decision for employers of all sizes. Throughout this guide, we’ve examined the fundamental aspects of these retirement vehicles, from their distinct characteristics to the various types available. The shift from defined benefit to defined contribution plans clearly demonstrates how employers now prefer these options due to their cost predictability and reduced long-term liability.
Every organization must evaluate its unique circumstances when selecting a plan. Company size, budget constraints, workforce demographics, and administrative capacity all play decisive roles in determining which option—whether a 401(k), SIMPLE IRA, SEP IRA, profit-sharing plan, or ESOP—will best serve both business objectives and employee needs.
Additionally, understanding your legal responsibilities cannot be overlooked. ERISA requirements, fiduciary duties, reporting obligations, and nondiscrimination testing form critical components of plan administration. Failure to meet these requirements can result in significant penalties and personal liability for plan fiduciaries.
The five-step selection process outlined provides a methodical approach to finding your ideal plan. First, define clear business goals. Second, match plan types to your specific needs. Third, consult qualified experts for detailed analysis. Fourth, implement effective communication strategies. Finally, establish regular reviews to ensure ongoing plan effectiveness.
Remember that retirement benefits serve as powerful tools for attracting and retaining talented employees. Though establishing a defined contribution plan requires careful consideration, the potential benefits—reduced turnover, tax advantages, and competitive positioning—typically outweigh the administrative investment.
Most importantly, view your retirement plan not as a static offering but as an evolving program that requires periodic assessment and adjustment. Market conditions change, regulations evolve, and workforce needs shift. Therefore, successful employers treat retirement plans as dynamic elements of their overall compensation strategy rather than set-and-forget benefits.
Your employees’ financial security during retirement depends largely on the decisions you make today. A thoughtfully selected defined contribution plan balances your organization’s financial capabilities with your workforce’s long-term needs—creating value for everyone involved.
References
[1] – https://www.tiaa.org/public/plansponsors/colalimits
[2] – https://www.irs.gov/pub/irs-tege/deva01.pdf
[3] – https://www.daypitney.com/insights/publications/2024/11/7-irs-publishes-2025-pension-plan-limits
[4] – https://www.ajg.com/news-and-insights/nondiscrimination-testing-for-qualified-retirement-plans/
[5] – https://www.pewtrusts.org/en/research-and-analysis/issue-briefs/2024/07/small-employers-economics-of-offering-retirement-savings-plans
[6] – https://www.investopedia.com/terms/d/definedcontributionplan.asp
[7] – https://www.nerdwallet.com/article/investing/roth-401k-vs-401k
[8] – https://www.schwab.com/learn/story/should-you-consider-roth-401k
[9] – https://www.irs.gov/retirement-plans/plan-sponsor/simple-ira-plan
[10] – https://www.irs.gov/retirement-plans/plan-sponsor/simplified-employee-pension-plan-sep
[11] – https://www.investopedia.com/articles/financial-advisors/022416/pros-and-cons-sep-account-todays-volatile-markets.asp
[12] – https://www.irs.gov/retirement-plans/choosing-a-retirement-plan-profit-sharing-plan
[13] – https://www.nceo.org/what-is-employee-ownership/esop-employee-stock-ownership-plan
[14] – https://www.ssa.gov/policy/docs/ssb/v75n2/v75n2p41.html
[15] – https://www.bls.gov/opub/btn/volume-5/defined-contribution-retirement-plans-who-has-them-and-what-do-they-cost.htm
[16] – https://www.bls.gov/news.release/ebs2.t01.htm
[17] – https://www.dol.gov/sites/dolgov/files/EBSA/about-ebsa/our-activities/resource-center/faqs/faqs-retirement-plans-erisa.pdf
[18] – https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-plans-definitions
[19] – https://www.irs.gov/retirement-plans/retirement-plan-fiduciary-responsibilities
[20] – https://www.irs.gov/retirement-plans/irc-notice-and-reporting-requirements-affecting-retirement-plans
[21] – https://www.dol.gov/sites/default/files/ebsa/about-ebsa/our-activities/resource-center/publications/reporting-and-disclosure-guide-for-employee-benefit-plans.pdf