Pension

A pension (also known as superannuation) is a retirement plan intended to provide a person with a secure income for life. Although a lottery may provide a pension, the common use of the term is to describe the payments a person receives upon retirement.

Defined Contribution Plans

In a defined contribution plan, the contribution is defined, but the benefit is unknown. A typical defined contribution arrangement is one under which contributions are made (by the employer, the employee, or both) into an account which grows via investment. At retirement, the employee has an account that can be used to purchase an annuity, or can have amounts withdrawn as the financial need for the employee arises.

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A very common type of defined contribution plan in the United States is the 401(k) plan, named after the Section of the Internal Revenue Service Code. Under a 401(k) plan, an employee contributes a portion of that employee's salary into to an account, before taxes are withheld. For example, an employee who receives $1,000 per week might contribute 5% of this amount, or $50. That employee would be taxed (for IRS and Social Security purposes) on only $950. The 401(k) account grows tax-deferred. Often, an employer contributes to the employee's 401(k) plan, either by matching employee contributions or through discretionary profit-sharing contributions. An employee's contributions are immediately vested, and employer contributions generally vest over the course of several years.

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Defined contribution pensions, once vested, are generally portable. If an employee leaves his or her employer, the account balance can be rolled over into individual retirement accounts or the next employer's 401(k) plan.

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In a defined contribution plan, investment risk and investment rewards are assumed by each individual/employee/retiree and not by the sponsor/employer. In addition, participants do not typically purchase annuities with their savings upon retirement, and bear the risk of outliving their assets.

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The "cost" of a defined contribution plan is readily calculated. But, the benefit from a defined contribution plan depends upon the account balance at the time an employee is looking to use the assets. So, for this arrangement, the contribution is known but the benefit is unknown (until calculated).

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