Defined Benefit Plan vs Defined Contribution Plan
A pension promising a specific benefit; the employer bears the investment risk. An individual account plan whose payout depends on contributions and returns.
What is the difference between Defined Benefit Plan and Defined Contribution Plan?
Defined benefit = the payout is promised, employer bears risk. Defined contribution = only the contribution is defined, employee bears risk.
| Defined Benefit Plan | Defined Contribution Plan | |
|---|---|---|
| In one line | A pension promising a specific benefit; the employer bears the investment risk. | An individual account plan whose payout depends on contributions and returns. |
| Example | A plan paying 1.5% of final average salary per year of service: 30 years at $100,000 = $45,000 a year. | Two employees contributing identically can retire with very different balances depending on their fund choices. |
| Unit | Retirement Plans, Accounts & Trading | Retirement Plans, Accounts & Trading |
| Series 65 | Section 3: Client Strategies | Section 3: Client Strategies |
What is Defined Benefit Plan?
Benefits follow a formula - typically salary and years of service - and an actuary sets the required employer contributions. Poor investment results mean the employer must contribute more. Private plans are insured by the PBGC. Can favor older, highly paid employees, since large contributions can be made for short remaining careers.
What is Defined Contribution Plan?
401(k), 403(b), profit-sharing, and money purchase plans. Each participant has an account; the eventual benefit is whatever it grows to, so the employee bears the investment risk. Contributions may be vested immediately or on a schedule.