Retirement 101: Defined benefit vs. defined contribution plans

When researching retirement account choices, you might come across the terms defined benefit plan and defined contribution plan. What’s the difference between the two, and do you get to pick and choose? (Typically, no.) How might your structure—defined benefit versus defined contribution—impact your retirement savings strategy?

Defined benefit plan vs. defined contribution plan

Basically, whether you get a defined benefit or defined contribution plan boils down to whether your company offers a pension plan or a 401(k) plan.

• A defined benefit plan, such as a pension, is one in which you receive a regular payout—typically monthly. Your benefit after retirement might be based on several factors, including years of service and salary (either your ending salary or an average over a certain number of years). In some cases, you can make extra contributions to your defined benefit plan to increase your potential payout.
• A defined contribution plan, such as a 401(k), is one in which you make contributions to your retirement account. Usually, your contributions are invested—either into a preselected target-date fund, or you may be able to choose from a list of exchange-traded funds and mutual funds. There is no set payout. Instead, what you end up getting during retirement depends on how much you put in and how the market performs over time. Employers can also make contributions to your defined contribution plan, often in the form of matched contributions. There are also certain individual retirement accounts (IRAs) that employers can use as defined contribution plans for their workers.

The main difference between defined benefits and defined contributions is who’s primarily responsible for your retirement income: your employer or you.

In some cases, you might have access to both types of plans. Or, if you’re an older worker, you might have a defined benefit plan from earlier in your career (when company pension plans were more prevalent) and a defined contribution plan now. You can still draw on your defined benefit plan during retirement, but it might not be enough to live on.

The rise of the defined contribution vs. defined benefit pension plan

There has been a significant shift among employers to offer defined contribution plans instead of pensions. According to the Congressional Research Service, 68% of workers had access to either a defined contribution or defined benefit plan as of 2021, but of those workers, only 15% had access to a defined benefit plan.

Some of the reasons for this shift include:

• Administrative costs. Employers that offer defined benefit plans face much higher costs versus those that offer defined contribution plans.
• Liability shift. A pension plan can become a massive liability on a company’s books and may become underfunded over time, putting both the company and its retirees at risk. Over the past few decades, most companies have chosen to shift the market-return liability to employees. These days, defined benefit plans are mostly available to government and municipal employees (these organizations have the power to levy taxes).
• Job-hopping is the norm. Some employees prefer the portability and flexibility of defined contribution plans.

The bottom line

There’s no getting around it: The onus will likely be on you to fund your retirement journey. Gone are the days when you could rely on an employer to take good care of you after years of loyalty—even many government employers are shifting to defined contribution plans. Social Security can help fill the gaps, but it can’t be relied on to fully fund your golden years.