Often referred to as a “DC” plan, these retirement planscan include 401(k)s (most common in the private sector), 403(b)s (used by educational institutions) and cash balance plans. In these plans, what is actually specified (or defined) as the employee’s benefit is the employer’s contribution to the retirement plan each pay period. (Of course, employees contribute too.) The benefit to governments is that the risk is taken on by the employee and makes planning for retirement benefits much easier. For example, Employee X will contribute 10 percent from his paycheck (pre-tax) to his pension fund and the government will match that. If the employee earns $80,000 per year that means that $16,000 is being stocked away in his retirement account annually. If that person works for 25 year, that means that a total of $400,000 will be invested into the retirement fund over that time
But that’s where the guarantee ends – depending on how the market does over those 25 years that employee’s pension could be worth more than double what was invested or it could be less than $400,000. That’s why the risk is taken on by the employee in 401(k)-style plans as there are no guarantees on what the employee will have upon retirement.