A defined contribution plan is an “account-based plan”. Each participant will have an account balance, which may be updated daily or on some other frequency. Various types of contributions can be made to DC plans, depending on the plan's design. This might include employee pre-tax contributions, Roth contributions, rollover contributions and various types of employer contributions (matching, profit sharing, core contributions, ESOP contributions, prevailing wage contributions, etc.). Depending on the plan design, investments may be directed by participants (usually the case in 401(k), 403(b) and 457 plans), or may be trustee-directed, in a uniform mix for all participants/ In a defined contribution plan, the employer sets up an arrangement through which various types contributions can be made, and defines the rules for these contributions (whether they are fixed or discretionary, the percentage or dollar amounts supported, etc.). The final account balance for a participant accumulates in a DC plan is driven by actual circumstances -- how much the participant and the employer contribute each year, how the participant invest their assets, the length of the accumulation period and independent factors, like how investment markets perform. In today's workplace, DC plans have become extremely popular due to their flexibility, portability and visibility, and the way they put participants in a position of control. Many participants also find that when they reach a personal milestone or "high water mark" in their DC plan, it can be a rewarding and motivating experience that brings the entire journey into perspective. In a defined benefits plan, also known as a pension plan, the employer is essentially "defining a benefit" that will be a payable to the participant at some future date. There are many types of DB plan designs. A traditional design might outline a lifetime benefit that will begin at a ge 67 of "2% of final average pay for each year you worked for the company". Under this formula, if an employee worked for the company for 20 years and had the final average pay of $50,000, he or she would receive a benefit of $20,000 per year (40 percent of $50,000) for life when they retire (on or after the plan's normal retirement age). In recent years, a new type of defined benefit plan has emerged called a Cash balance Plan. This provides a certain "dollar amount" benefit to the participant that is guaranteed, (expressed as a dollar amount, with annual service and interest credits and a minimum and derived through a formula) for the employee at retirement age. Defined benefit plans are essentially "promises to pay" a certain benefit. As such, they involve liability for the employer, required annual funding and a valuation performed by an actuary.
While each employer will make decisions as to which combination of retirement programs are best suited to their workforce, DC and DB plans both play a vital role in the American workplace.