What is the difference between a defined benefit and a defined contribution pension plan?

By Carolyn Grimes
October 28, 2016

These retirement benefits are for private service. There is a federal law called the Employee Retirement Income Security Act (ERISA) that governs private pensions and 401(k) plans, things like that. These terms apply to the private sector.

There are separate laws that govern federal government pensions and retirements and state government pensions and retirements. These only apply to private pensions. If you work for corporations like IBM or Hewlett Packard, this is what applies to you. A defined benefit plan is what people typically think of as a pension. It's an amount of money that's paid to you every month when you retire.

Defined benefit means, in structuring the plan, the company decides the benefits they want to pay at the end. That's why it's called a Defined Benefit Plan, not necessarily the amount of money that goes in. The company will decide, for example, that they want a pension plan that pays employees who make $80,000 a year $2,000 a month when they retire. That's what a Defined Benefit Plan is, and then it's funded either by employer contributions only or employee contributions.

When you have a client who’s got deductions on their pay stub for retirement plan, that's your first clue to think, Hey, there's a retirement plan here. Then you need to find out what kind it is. A defined contribution plan is what a 401(k) is. There's no set goal as to how much money you're going to have at the end. What the company has decided is that they're going to define how much is contributed.

Usually, there's an employer match, and also usually there is an employee contribution – and again, that will be on the pay stub and on the W2.

401(k) is typically what people think of as a Defined Contribution Plan. There are a couple other ones out there. 403B is when you work for a school system. It's the same thing though. You put an amount of money and the employer puts an amount of money in and it grows. It takes its chances in the stock market, basically, and there's no set amount at the end. Those are the basic differences between those two.

Carolyn Grimes is a family lawyer at the law firm of Wade Grimes Friedman Sutter & Leischner PLLC in Alexandria, Virginia. To learn more about Grimes and her firm, visit www.oldtownlawyers.com.

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October 28, 2016
Categories:  FAQs

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