Terms

Defined Benefit Plan

In a defined benefit plan, the formula for determining benefits is what guarantees the benefit. Traditionally, the formula is, in some way, based on number of years of employment and salary. The uncertainty came on that the money paid in to fund the plan might not be the correct amount. It is hard to predict what the final salary of the retiree might be, or the expected rates of return or remaining years of life will be -- especially during the early years, as the employee begins to build "credits" within the plan.

Defined Contribution Plan

A defined contribution plan, on the other hand, makes no determination of the benefits to be paid. It defines solely the amount to be contributed during the employee's working career. At the end of that career, what has been saved (plus any gain) is what is available for a benefit.

Comparison of Risk

The key difference is in who bears the risk. In a defined contribution plan, the employer bears the risk that assets will not grow quickly enough to cover the guaranteed benefit and additional contributions will be necessary.

In the defined benefit plan, the employee carries the risk that the amount saved will not grow fast enough to provide the expected pension.