Defined Contribution vs. Defined Benefit Pension Plans: Understanding Your Options

The two broad categories which all pension plans belong to are defined contribution plans and defined benefit plans. Your employer will decide which to offer to you, and you will have to make your contributions and elections based on this benefit from your employer.

Defined-Contribution Pension Plan

These plans rely on you to invest funds each paycheck, or each year. Depending on how much you have placed in your pension account, you will receive a payment schedule upon your retirement. Examples of contribution plans include employee stock ownership plans (ESOP), 401k plans and profit sharing options.

Defined-Benefit Pension Plan

In a defined-benefit plan, you are paid based on a formula that determines your benefit to the company. The amount of time you worked with the company and your salary while there will have a lot to do with your benefit amount. Your employer may contribute on your behalf weekly, monthly, annually or even every few years. It is common for employers to deposit bonuses in this account based on your performance in a given year. Examples of this type of plan include cash balance plans, money purchase plans and simplified employee pension plans (SEP).

Defined Contribution Plan

A defined-contribution plan is a retirement benefit account offered by an employer to an employee. The amount of each contribution is defined in an employment contract, and the contribution amount may increase with employee loyalty over time. However, the account is open to investment, and the ultimate benefit received at the time the employee retires is not defined. This means the employee's retirement savings will partly depend on how well the funds have been invested. A defined-contribution plan is a common form used for an employer-paid 401(k) managed by the corporation.