Defined benefit vs. defined contribution plan: What's the difference?

Defined benefit plans and defined contribution plans are two primary categories of employer-sponsored retirement plans, and they both can help you save along your journey toward retirement.

The main differentiators fall around who primarily funds the plan, control over contributions and portability.

A defined benefit plan, commonly known as a pension, is administrated and funded by an employer.

Here's how they work:

• Employers make contributions to the pension plan periodically or annually. The amount uses a retirement income calculation based on an employee's years of service with the company, their age and their salary.
• The money will grow in the account tax-deferred, which means your tax liability won't come until you take withdrawals in retirement.
• When it's time to retire, the plan determines the distribution options. But generally, the employee may be able to take a lump-sum payment or may have an annuity payment plan paid monthly until their death.

In the past, pensions were a more common offering through employers. Now, more have opted to offer defined contribution plans in their place.

Defined contribution plans are employer-sponsored retirement plans where money is put in regularly over time, either by you or your employer. Common types of defined contribution plans where employees do most of the contributing include 401(k)s, 403(b)s and 457(b)s. These can be supplemented with employer contributions as well. Some defined contribution plans are funded entirely by the employer, such as profit-sharing and money purchase pension plans.

Employer- and employee-funded defined contribution plans are similar, but we'll focus here on the plans where you control the contributions:

In most cases, you select a percentage of your salary to be directed to your chosen type of plan via payroll deduction. The funds will be put toward the investments you selected from your employer's offerings. If applicable, an employer also may match your contributions. If your company offers an employer match, be sure to take advantage of it. If you don't, you're essentially leaving free money on the table.

You may be able to choose between a traditional or Roth version of the retirement plan your employer offers. The main difference lies in the tax treatment.

Traditional versions of the plans are tax-deferred. This means they are funded with pre-tax contributions, which will lower your taxable income for the year. The contributions and earnings will grow tax-deferred over time. Your tax liability will come once you start taking withdrawals in retirement. With traditional accounts, you must start making required minimum distributions (RMDs) at a specific age determined by your birthdate.

Bottom line: This type of plan may be best for those who think they will be in a lower tax bracket when they retire.

Roth versions, such as a Roth 401(k), are funded with contributions you've already paid tax on, so you have no additional tax liability when you take withdrawals of your contributions in retirement. Additionally, earnings will grow tax-tree in Roth accounts, and can be withdrawn tax free if you meet the requirements for a qualified distribution.* Unlike traditional accounts, starting in 2024, the SECURE Act 2.0 removed the RMD requirement from Roth defined contribution plans.

Bottom line: This type of plan may be most appropriate if you think you will be in a higher tax bracket in retirement.

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In a defined benefit plan, the amount of the pension is predetermined—employees know exactly how much they'll be given in retirement.

Defined contribution plans are not guaranteed. The amount you have when you enter into retirement will vary based on your contribution amounts, investment choices and the market's behavior.

An advantage of a defined benefit plan or pension is the risk belongs to the employer since they are responsible for funding it. However, pension plans provide little to no flexibility. Your employer determines your contribution, chooses the investments and manages it all.

With defined contribution plans, the risk is usually on you if you're the one making the investment choices. Unless your employer doesn't allow self-directed accounts, you'll pick from a curated selection of investment options and are generally able to make account changes and adjust your contributions as needed. Your investments will gain or lose value based on market performance.

Defined benefit plans limit how much you can receive. Participants can receive an annual maximum compensation of either 100% of the employee's average salary for their highest-earning three consecutive calendar years or, a maximum of $265,000 in 2023 or $275,000 in 2024.

For defined contribution plans, the IRS limits how much employees can contribute to their plans each year. The elective salary deferral limit is $22,500 in 2023 or $23,000 for 2024 for employees younger than 50.

If you're 50 or older, you can make additional catch-up contributions up to an additional $7,500 on the of the annual limit. Your employer's matching and nonelective contributions are not included in that limit. Those can be added to the elective salary deferral.

Combined total annual limits:

• 2023: $66,000 for people younger than 50 or $73,500 for ages 50 or older—or 100% of your compensation, whichever is less.

• 2024: $69,000 for people younger than 50 or $76,500 for ages 50 or older—or 100% of your compensation, whichever is less.

Both defined benefit and defined contribution plans usually involve vesting—that is, you get full ownership of the account funds after a certain amount of time working for your employer. If you leave a job with a defined benefit plan and are vested, you may not be able to take the account as-is with you to another job. Your plan will outline your options, which may be limited to receiving monthly annuity payments in the future. A lump-sum distribution may or may not be an option, but if it is, you may be able to roll that money into a new employer plan or an IRA.

If you leave your job, you may be able to take your vested balance from your defined contribution plan and:

• Keep it in your old employer's plan
• Roll it over to your new employer's plan or into an individual retirement account
• Cash it out (though if so, you may have to pay taxes and penalties)

It's understandable to prioritize predictability when planning your future. If given the option, you may prefer a defined benefit plan because you'll have more certainty about your retirement income, which can help shape the rest of your savings goals. But if you value flexibility and choice most of all, a defined contribution plan will have more to offer.

Whether you have a pension, a 401(k) or another type of defined benefit or defined contribution plan, you may want to work with an expert who can guide you through the planning process. You can connect with a local Thrivent financial advisor, who will help to balance your values and goals with the right retirement strategy for you.