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Defined contribution plans require or permit employees, and sometimes employers, to make contributions up to an annual limit. The actual payout in retirement depends on how much participants choose to contribute and how their investments perform.
A defined benefit plan, most often known as a pension, is a retirement account for which your employer ponies up all the money and promises you a set payout when you retire. A defined contribution plan, like a(k) or(b), requires you to put in your own money.
Because defined benefit plans are more costly for employers than defined contribution plans, most of them have – you guessed it – scaled back dramatically or eliminated these plans altogether in recent years. If you still have a defined benefit plan at your company, consider yourself lucky.
In general, defined benefit plans come in two varieties: traditional pensions and cash-balance plans. In both cases, you just show up for work and, assuming you meet basic eligibility rules, you’re automatically enrolled in the plan. (In some instances, however, you aren’t enrolled until you’ve completed your first year on the job.) You also need to stick around on the job for several years – typically five – to be fully “vested” in the plan. The difference is in how the benefits are calculated; in a pension, it’s based on a formula that takes into account how long you were on the job and your average salary during your last few years of employment. The cash-balance plan credits your account with a set percentage of your salary each year.
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