Understanding Retirement Plans: DC and DB Plans Explained

Retirement plans are crucial for financial security. Defined Contribution (DC) and Defined Benefit (DB) plans are two primary types, each with distinct features, benefits, and limitations. Understanding these can profoundly affect retirement outcomes.

DC plans, like 401(k)s, allow individuals to contribute a portion of their salary into an investment account. The retirement benefit depends on contributions and investment performance, shifting the investment risk to the employee.

DB plans, commonly known as pensions, promise a specified monthly benefit at retirement. The amount is predetermined by a formula based on earnings history, tenure of service, and age, placing investment risk on the employer.

The key difference lies in risk assumption. DC plans expose employees to market risk, whereas DB plans guarantee a set benefit, with employers managing funding and investment risks to ensure they can pay retirees.

There's been a shift from DB to DC plans over recent decades. Reasons include cost predictability for employers, the move towards employee mobility, and regulatory changes that made DB plans more complex and costly.

DC plans offer greater portability, suiting a modern workforce that changes jobs frequently. Employees can roll over their savings into a new employer's plan or an individual retirement account without losing their accrued benefits.

DC plans offer participants more control over their investments, allowing them to tailor their portfolio to personal risk preferences. Conversely, DB plan participants have no direct control over the investment decisions.