What is a Non-Contributory Plan? (2024)

Non-Contributory Plan

A non-contributory plan is a type of benefit plan, often a pension or retirement plan, in which all the contributions are made by the employer, and the employees are not required to contribute financially.

In these types of plans, the employer assumes the full cost of the employees’ benefits. This can be a major advantage for the employees, as they receive these benefits at no direct cost to them. Employers might offer non-contributory plans to attract and retain talented employees.

For example, a company might have a non-contributory defined benefit pension plan. In this plan, the company promises to pay its employees a certain amount of money in retirement, based on factors like years of service and salary. The company is solely responsible for making the necessary contributions to the plan and ensuring that there’s enough money to pay the promised benefits.

While non-contributory plans can be attractive to employees, they can also represent significant financial commitments for employers. Therefore, it’s crucial that employers carefully manage these plans to ensure they can meet their obligations.

Example of a Non-Contributory Plan

Let’s consider a hypothetical company, XYZ Corp, that offers a non-contributory defined benefit pension plan to its employees.

In this scenario, XYZ Corp promises to pay each of its employees a monthly pension when they retire. The amount of the pension is based on each employee’s salary and years of service. For instance, an employee who retires after 30 years of service might receive a pension equal to 60% of their average salary during their last three years of employment.

XYZ Corp is responsible for funding this pension plan. The employees don’t contribute anything themselves – that’s why it’s a non-contributory plan. XYZ Corp might hire actuaries to calculate how much it needs to contribute each year to ensure that it can meet its future pension obligations. It then invests these contributions, aiming to grow the pension fund over time.

So, if an employee retires after 30 years and their average salary over the last three years was $80,000, they would receive a yearly pension of $48,000 (60% of $80,000) from XYZ Corp. They receive this benefit without having ever contributed to the pension fund themselves.

This is a significant benefit for the employees, and it can help XYZ Corp attract and retain talented staff. However, it also represents a significant financial commitment for XYZ Corp, which needs to carefully manage the pension fund to ensure it can meet its future obligations.