Final answer:
Employers have the most flexibility in contributions with profit-sharing plans due to their discretionary nature. Defined contribution plans like 401(k)s are preferred over traditional defined benefit plans because they are flexible, tax deferred, and portable. Profit-sharing plans also protect against inflation-related losses in retirement savings.
Step-by-step explanation:
Employer Contributions to Retirement Plans
Employers maintain the greatest flexibility in the amount of contribution to a qualified retirement plan by adopting a profit-sharing plan. Unlike defined benefit plans and money purchase pension plans, which have fixed contribution formulas, profit-sharing plans allow employers to determine the amount contributed each year, which can vary based on the profitability of the company. This contrasts with defined benefit plans, where benefits are determined by a set formula and the employer bears the investment risk, and money purchase plans, that require fixed annual contributions. Profit-sharing plans are a type of defined contribution plan where contributions are typically made at the discretion of the employer, varying from year to year.
Defined contribution plans like 401(k)s and 403(b)s have gained popularity over traditional defined benefit plans due to their flexibility and portability. These plans involve fixed contributions from the employer and often from the employee, with the funds being invested in a range of investment vehicles. They are designed to be tax deferred and portable, which is beneficial if an employee changes employers.
The primary challenge for traditional defined benefit plans is that they often provide a fixed income that does not increase over time, leaving retirees vulnerable to the erosive effects of inflation. Profit-sharing plans can alleviate this issue by allowing contributions to fluctuate with the economic condition of the business, potentially enhancing the retirement savings for employees.