What is the difference between defined contribution and defined benefit plans?

The distinction between defined contribution and defined benefit plans is fundamentally rooted in how retirement benefits are calculated and what risks are borne by the employer versus the employee.

Defined contribution plans are characterized by fixed monthly contributions made by the employer (and sometimes the employee) to individual accounts. The future retirement benefits from these plans are dependent on the performance of the investments made with those contributions, so the final amount available at retirement can fluctuate based on various factors, including market conditions.

In contrast, defined benefit plans promise a specific benefit amount upon retirement, typically calculated based on a formula that includes factors such as the employee’s salary history and years of service. This means that the final benefit is predetermined and not directly affected by investment performance, placing the investment risk on the employer, who must ensure they can meet the promised payouts.

The choices presented include misconceptions, such as the belief that defined benefit plans are always superior for employees, which overlooks individual circumstances and market conditions. Additionally, the notion that defined contribution plans are government-mandated is incorrect; such plans are optional and vary widely by company and jurisdiction.

Thus, the correct answer highlights that defined contribution plans have fixed contributions, while defined benefit plans depend on future variables, providing clarity on how each plan operates and their