Retirement plans may be categorized as either defined benefit plans or defined contribution plans.
About Defined Benefit Plans
A defined benefit plan identifies the specific benefit that will be payable to you at retirement. Your basic retirement benefit usually is based on a formula that takes into account factors like the number of years a participant works for the employer (years of service) and the participant’s salary (e.g., average of highest three or five years of earnings). Your retirement benefit generally is provided in the form of regular payments over your lifetime beginning at what the plan designates as normal retirement age, which is typically age 65. This stream of periodic payments generally is known as a pension or sometimes called an annuity.
About Defined Contribution Plans
A defined contribution plan specifies how much money will go into a retirement plan today. The amount typically is either a percentage of an employee’s salary or a specific dollar amount. Those funds are generally invested in mutual funds or annuities available inside the retirement plan. The amount you have at retirement depends on how much (if anything) your employer contributes to the plan, how much you as the employee save in the plan, how long you leave those funds invested, and how well your investments perform inside the plan.
During the past two to three decades, many employers have replaced defined benefit plans with defined contribution plans, primarily due to the expense and long-term obligations associated with running a defined benefit plan. If you still have a defined benefit plan through your employer, be sure to regularly let your employer know that you really appreciate your retirement plan; it’s a benefit well worth keeping.