Retirement plans fall into two basic categories:

Also known as a traditional pension, it pays a retiree a specific benefit based on years of service and salary level until they die. In some cases, the payout will continue for a spouse or a beneficiary.

Put simply, they are called Defined Benefit because you know what you are going to get when you retire.

Defined Contribution Plans are normally known by their IRS Tax Code, like 401k, 403(b), etc. DC plans allow the employee to make pre-tax contributions to their own retirement account. Employers may make matching contributions up to a certain amount.

Your employer serves as a “plan sponsor” and has another company administer the plan and its investment. This plan administration is typically a mutual fund company, a brokerage firm, or an insurance company.

You are responsible for the investment of your money by choosing investment options in the plan. Contribution limits are set every year to adjust to the high cost of living.

• 401k is essentially a retirement savings account which offers tax advantages. It doesn’t have the lifetime payout like pension plans.
• 403(b) is similar to 401k but is available only for employees of tax-exempt organization, like schools, hospitals, or religious organizations.
• 457 plans in general have similarities to 401k and are available to state and local public employees and to certain non-profit organizations.

Defined contribution plans invest with pre-tax contributions. Thus, withdrawing money before 59 ½ will be subject to early withdrawal penalties with some exceptions. And of course all distributions will be taxed as ordinary income.

These plans are called Defined Contribution because you know what you put in. But you won’t know what you may get when you retire due to market fluctuations.

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