Defined Benefit vs. Defined Contribution Pension

A defined benefit (DB) pension promises you a specific monthly income in retirement, usually based on a formula involving your salary and years of service. If the formula says you’ll get $3,000 per month at age 65, that’s what you get, regardless of what the stock market does. Your employer takes on the investment risk.

A defined contribution (DC) pension works differently. You and your employer both contribute money into an account, and you choose how to invest it (usually from a menu of funds). Your retirement income depends entirely on how much was contributed and how well those investments performed. You take on the investment risk.

Why it matters

Defined benefit pensions are increasingly rare outside of government and some large unionized employers. They’re valuable because the income is predictable. You know what you’ll receive, which makes retirement planning much simpler.

Defined contribution pensions are more common in the private sector. They’re essentially a workplace investment account, similar to a group RRSP. The employer match is often the best part. If your employer matches your contributions dollar for dollar up to a certain percentage, that’s an immediate 100% return on that money. Always contribute at least enough to get the full match.

The big difference comes down to who bears the risk. With a DB pension, your employer guarantees the outcome. With a DC pension, your retirement income depends on market returns and the investment choices you made along the way.

Example

Consider two people who both worked for 30 years. The one with a DB pension might receive $2,800 per month for life starting at age 65, guaranteed by the plan. The one with a DC pension contributed $300 per month alongside a $300 employer match. If those contributions earned an average of 6% per year, the account would be worth roughly $600,000 at retirement. That’s a solid amount, but how long it lasts depends entirely on how they invest and withdraw from it.

If you have a DC pension, it’s worth paying attention to what funds you’re invested in. Many default options carry higher fees than what you’d find in a self-directed account, and those fees compound over a career.