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Retirement 101


Defined Benefit vs. Defined Contribution
 
There was a time when employers offered one kind of retirement plan: a pension plan. You worked for many years for the same employer, and you got a monthly check when you reached retirement age. These days, though, other kinds of retirement plans are being offered as alternatives to traditional ("defined benefit") pension plans. These other retirement plans don't use a formula to determine your retirement benefit. They are often described as "defined contribution plans." So what's the difference between the two?
 
  • Defined benefit plans include traditional retirement plans such as the FRS Pension Plan. Your benefit is "defined" based on a formula that uses factors such as service, age, and pay.
  • Defined contribution plans include the FRS Investment Plan, as well as 403(b), 457 and 401(k) plans. What's "defined" are contributions made to this kind of plan, rather than your benefit. Your benefit is based on contributions to your account, as well as your account's investment earnings. Your investment earnings will depend, to a large extent, on how much risk you are willing to take and the fees charged to you by the investment funds. "Portability" and "control" are two terms often used to characterize these types of plans because you can take your retirement plan with you to a new job and you control the way your account is invested.

 
Here's how to tell a defined benefit plan from a defined contribution plan:
Defined Benefit Plans Defined Contribution Plans
How it's funded Contributions depend on how much is necessary to fund the benefits paid to all participants, and are put in a pool (determined by an actuary) Contributions are typically based on a percentage of pay and are put in your account
Who invests, takes on risks and rewards Employers Employees
Your benefit — the amount you receive Based on a formula using your service, age and pay. Depends on contribution amounts and the performance of investment funds you choose (including fees charged to you by those funds)
Examples
  • FRS Pension Plan
  • Traditional employer-sponsored pension plans
  • Social Security
  • FRS Investment Plan
  • 403(b), 457 and 401(k) plans
  • Money purchase plans
  • Individual Retirement Accounts (IRAs)
It may seem that your comfort with making investment decisions is the biggest factor when you have a choice between a defined benefit and defined contribution retirement plan. However, it's not the only factor -- in many cases, the amount of time you spend with your employer makes an even bigger difference. In any event, no matter which plan you choose, personal savings is practically a necessity to ensure that you have enough income in your retirement years to lead the lifestyle you want.

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