Investment Company and Variable Contracts Products Representative (Series 6)Practice Exam

In a defined contribution plan, who bears the investment risk?

1. Employee

2. Employer

3. Plan fiduciary

4. Brokerage firm

The correct answer is: Employee

In a defined contribution plan, the investment risk is primarily borne by the employee. This type of retirement plan allows employees to contribute a portion of their salary to individual accounts, and the eventual retirement benefits depend on the performance of investment options chosen by the employee, such as stocks, bonds, or mutual funds. Since the employee selects the investments and is responsible for the performance of their account, they are significantly exposed to investment risk. The employer typically contributes to the plan as well, but they do not bear the investment risk associated with the employee's account. Instead, the employer’s obligation usually involves matching contributions or providing a set contribution regardless of investment outcomes. The fiduciary may have responsibilities related to overseeing the plan, ensuring it operates within regulatory guidelines and serves the best interests of participants, but they do not directly shoulder the investment risks associated with individual accounts. Brokerage firms facilitate the transactions within the defined contribution plans but are not responsible for investment risk; their role is more about providing the platforms and tools for investing rather than taking on any risk associated with the performance of those investments. Thus, the correct answer reflects the reality that the employees themselves are the ones exposed to the fluctuations and uncertainties of market performance.