When planning for retirement, understanding the structure of your retirement plan can significantly impact your financial future. Two primary types dominate the landscape: Defined Benefit (DB) plans, commonly known as pensions, and Defined Contribution (DC) plans, such as 401(k)s. Though both aim to support retirement income, they differ greatly in how they are funded, who bears the investment risk, and the predictability of retirement benefits.
This article breaks down the key differences, benefits, and trade-offs between DB and DC plans—helping business owners, HR professionals, and workers make informed decisions.
What Is a Defined Benefit Plan?
A Defined Benefit Plan promises a specific retirement benefit, often a monthly payment for life, calculated using a formula based on salary history and years of service. For example, a typical formula might be:
Annual Benefit = 2% × Years of Service × Final Average Salary
Employers are responsible for funding the plan and managing the investments to ensure that promised benefits are paid out. If there is a shortfall, the employer must make up the difference.
Key Features:
Predictable income: Retirees receive a guaranteed benefit.
Employer-funded: Contributions are usually made entirely by the employer.
Investment risk: Borne entirely by the employer.
Often insured: Private sector DB plans may be backed by the PBGC (Pension Benefit Guaranty Corporation).
What Is a Defined Contribution Plan?
A Defined Contribution Plan (like a 401(k), 403(b), or SIMPLE IRA) is a retirement plan where contributions are defined up front—typically as a percentage of salary—but the final benefit depends on investment performance.
Employees usually contribute to their own accounts, often with employer matching. Investment choices are typically made by the employee within a menu of options.
Key Features:
Variable retirement income: Final benefit depends on contributions and investment returns.
Employee-funded: Contributions primarily come from employees, sometimes with employer matches.
Investment risk: Borne by the employee.
Portability: Account can often be rolled over between jobs.
Major Differences at a Glance
| Feature | Defined Benefit (DB) | Defined Contribution (DC) |
|---|---|---|
| Retirement Benefit | Predetermined formula | Based on account balance |
| Investment Risk | Employer | Employee |
| Contributions | Employer-funded | Employee + employer |
| Predictability | High | Low to medium |
| Portability | Limited | High (rollovers allowed) |
| Administration Cost | Higher for employer | Lower for employer |
Pros and Cons of Defined Benefit Plans
Pros:
Stable income for retirees, often for life.
Encourages employee retention, since benefits grow with tenure.
Can be a powerful recruitment tool for older or risk-averse employees.
Often includes survivor and disability benefits.
Cons:
High cost and funding responsibility for employers.
Complex to administer and subject to strict regulatory oversight.
Less flexible for younger, mobile workforces.
Pros and Cons of Defined Contribution Plans
Pros:
Portability suits modern, mobile careers.
Employees can customize investments to their risk tolerance.
Lower cost and liability for employers.
Employees build ownership over their retirement savings.
Cons:
No guaranteed income—market downturns can jeopardize retirement.
Relies heavily on employee discipline to contribute and invest wisely.
Greater exposure to fees and investment mistakes.
Trends and Shifts in Retirement Planning
Over the past few decades, the U.S. retirement landscape has shifted dramatically away from DB plans toward DC plans. In 1980, about 60% of private-sector workers had access to a defined benefit plan; by 2020, that number had dropped to under 15%. Meanwhile, 401(k)-style DC plans have become the default retirement option in most industries.
This change has transferred the burden of retirement planning from employers to employees, raising concerns about whether future retirees will have sufficient savings to retire securely—especially those who didn’t start saving early.
Which Plan Is Better? It Depends.
The best plan depends on several factors, including:
For employers: cash flow, workforce demographics, administrative capacity, and risk appetite.
For employees: career stage, income level, risk tolerance, and mobility.
Younger, mobile workers may prefer the flexibility of a 401(k). Older employees or those with long tenures might value the security of a pension. For high-income professionals or business owners, a custom-designed DB plan can offer massive tax-deferred savings, sometimes exceeding $100,000 per year in contributions.
Combining Plans for Flexibility and Security
Some businesses implement hybrid plans, such as cash balance plans, which combine features of both DB and DC models. These allow for predictable benefits like a pension but are expressed as account balances, which are easier for employees to understand and more portable.
Another strategy is stacking a DB plan with a 401(k), giving business owners and key employees the ability to supercharge retirement savings while still offering a DC plan for the rest of the workforce.
