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Defined Contribution Plan

A defined contribution plan provides an individual account for each participant. The benefits are based on the amount contributed into the plan and are also affected by income, expenses, gains and loses. There are no promises of a set monthly benefit at retirement. Some examples of defined contribution plans include 401(k) plans, 403(b) plans, employee stock ownership plans and profit sharing plans.

Advantages of Defined Contribution Plans

• Tax deferred retirement savings medium
• Participants usually have a say in how much they choose to save
• Can be funded through payroll deductions
• Lump sum distributions may be eligible for special 10 year averaging
• Participants can benefit from good investment results


• Easily understood by participants

Disadvantages of Defined Contribution Plans

• Difficult to build a fund for those who enter late in life
• Participants bear investment risk

Defined Benefit Plan

A defined benefit plan promises the participant a specific monthly benefit at retirement and may state this as an exact dollar amount. Monthly benefits could also be calculated through a formula that considers a participants salary and service. Unlike defined contribution plans, the participant is not required to make investment decisions. A defined benefit plan is sometimes referred to as a fully funded pension plan.

Advantages of Defined Benefit Plans

• Guaranteed retirement income security for workers
• No investment risk to participants
• Cost of living adjustments
• Not dependant on the participant's ability to save

Disadvantages of Defined Benefit Plans

• Difficult to understand by participant
• Not beneficial to employees who leave before retirement

More and more employers are moving away from defined benefit plans in favor of the defined contribution plan. Defined benefit plans are complex and very costly for the employer to maintain. The employer must maintain an account for the plan and decide the investments to keep the account growing. A defined contribuition plan requires quite a bit of management by both the employer and the employee but is less costly to the employer in the long run. By choosing a defined contribution plan, the employer puts the responsibility of investing in the hands of the employee.