Pensions and Defined Contribution Plans

Contents

1. The defined benefit standard
2. The defined contribution alternative
3. How the shift happened
4. What the data record
5. What it changed for retirees
6. The pension vocabulary worth knowing

Clients have sat with Brent O’Mara through deaths in the family, and the pension check that stops or continues after a death is where the subject of this entry becomes concrete. The standard itself is the defined benefit pension: a fund an employer builds and manages to pay a set income to employees in retirement, calculated by formula rather than by what any account happens to be worth.² The National Council on Aging gives the formula as years in the plan multiplied by final average salary multiplied by the plan’s benefit percentage, so that an employee with 35 years, a final salary of 70,000 dollars and a 2.5 percent factor would receive 61,250 dollars a year.² In one working lifetime that standard gave way to the employee account, and the data on coverage and balances record the shift.

The defined benefit standard

Two features define the standard. The employer bears the investment result, since the benefit is fixed in the plan documents, and the benefit arrives as a payment for life, though a cash balance variant states the promise as an account balance that can be taken as a lump sum with a spouse’s consent and rolled to an IRA.² Benefits vest on a schedule, either a cliff of one to five years or a seven year graded scale, and anything unvested reverts to the employer when the employee leaves.² Federal law under ERISA requires a benefit for the surviving spouse of a participant, commonly half or three quarters of the original payment, and any change to it needs that spouse’s written consent; the same law created a federal insurer that pays benefits, not always in full, when an employer’s plan fails or is terminated.² Some public plans sit outside Social Security altogether, and two provisions, the Windfall Elimination Provision and the Government Pension Offset, can reduce the Social Security benefits of people who also hold such a pension.²

The defined contribution alternative

A 401(k) plan, in the IRS definition, is a qualified plan with a feature allowing an employee to have the employer contribute part of the employee’s wages to an individual account, where the deferred wages escape federal income tax withholding until distribution and investment gains are not taxed until then either; a Roth option taxes the deferral up front instead.³ Employers may match, for example 50 cents for each dollar an employee defers, and may subject their own contributions to a vesting schedule, while an employee’s own deferrals are always fully vested.³ Traditional plans must pass yearly tests to show that deferrals and matches do not favor highly paid employees, safe harbor plans escape those tests by making fully vested contributions, and a Simple 401(k) serves employers with 100 or fewer employees.³ Automatic enrollment, which deducts a set percentage unless the employee opts out, has proved an effective way to raise participation, and for 2024 no more than 345,000 dollars of a person’s pay could be counted when figuring contributions.³

Figure

Defined benefit plans as a share of private plans filing with the Labor Department

• 197533
• 199016
• 20007

How the shift happened

In 1975, the first year after ERISA, a third of all private plans filing annual reports with the Labor Department were defined benefit plans. By 1990 the share was under 16 percent, by 2000 about 7 percent, and it has stayed near there since, with the number of large defined benefit plans still falling while small ones grew from 2012 to 2022.¹ The department lists the causes: the introduction of 401(k) type plans in 1978, the employer’s control over the size and timing of contributions, portability for workers who change jobs, lower and more predictable costs, and the simpler administration of a plan whose liabilities do not depend on actuarial assumptions.¹ Inc. magazine’s encyclopedia tells the origin story: defined benefit plans were common at large firms from the 1950s into the 1980s, until an obscure provision of the Revenue Act of 1978 went largely unnoticed for two years before Ted Benna, a Pennsylvania benefits consultant, devised the application that became the 401(k) plan, which many writers credit with letting small businesses offer what only large employers once could.⁷

Figure

Defined benefit beside defined contribution

	Defined benefit pension	Defined contribution plan
Who pays in	the employer funds and manages a plan built to deliver a set income	the employee pays in on a tax deferred basis, often with an employer match
What is promised	a predetermined retirement income for every qualified employee	a set contribution, with no promised benefit
Who chooses the holdings	the employer and its plan	the employee, in most cases
When it was common	the 1950s through the 1980s at large companies	after the 401(k) provision of 1978

What the data record

The Census Bureau’s 2022 survey found that 48 percent of adults 65 and over received some retirement income apart from Social Security, 53 percent of men and 44 percent of women, with a median of 17,160 dollars a year among recipients.⁴ The old standard still outnumbered the new at that age: 26 percent received pension income, 16 percent income from an IRA and 10 percent from a 401(k) type account, with 15.2 million people drawing a pension against 5.6 million drawing on a 401(k).⁴ Research funded by the National Endowment for Financial Education found that Americans with 401(k)s had saved about a third of what they needed to keep their living standard, that only about half of workers had access to an employer plan and only half of those participated, and that 93 percent of low income men had no 401(k) at all; by age 70, 96 percent of American men had seen their yearly earnings drop by more than a tenth at least four times, and those shocks often sent people into their retirement accounts long before retirement.¹⁰

Figure

Retirement income at 65 and over in 2022

of adults 65 and over received some retirement income

48 percent

received income from a pension

26 percent

received income from a 401(k) type account

10 percent

median yearly retirement income among those receiving any

$17,160

What it changed for retirees

The Center for Retirement Research measured the consequence in two ways. Its National Retirement Risk Index put 53 percent of households at risk of a lower standard of living in retirement in 2010, up from 45 percent in 2004 and from just under a third at the end of the 1980s, an erosion the center tied to the near extinction of traditional employer pensions; older boomer households with 401(k)s then held a typical 120,000 dollars, and all older boomer households a typical 42,000.⁶ A 2018 summary found that a middle income Generation X worker could expect savings to supply 42 percent of retirement income, against 27 percent for retirees born during the Depression and the Second World War, and that the monthly pension check had once made the hardest arithmetic of retirement, how much of a nest egg to spend, a simpler problem.⁵ That arithmetic is now the subject of the four percent rule and of required minimum distributions. Whether to take a pension as monthly income or as a lump sum, and how a plan’s tax treatment fits the rest of a household, depend on each family’s circumstances and call for qualified professionals.

The standard survives most visibly in public employment. Nebraska’s school employee retirement plan, which covers teachers outside the Omaha Public Schools system, stood at 99.91 percent funded in early 2025 with more than 16 billion dollars, among the healthiest in the country by the state teachers’ association’s account, after teachers agreed in 2013 to cover 80 percent of a 100 million dollar shortfall and the state raised its contribution from 1 to 2 percent of pay.⁹ KETV reported in April 2025 that lawmakers gave first round approval to a compromise scaling back contributions from the state, districts and teachers as the plan reached full funding, saving the state an estimated 77 million dollars over two years and adding about 1,000 dollars a year to a teacher’s take home pay.⁸

The pension vocabulary worth knowing

Defined benefit. A plan that promises a set retirement income by formula, funded and managed by the employer.²

Defined contribution. A plan that fixes what goes in, with the result depending on the holdings the employee chooses.⁷

Elective deferral. Wages an employee directs into a 401(k) account before income tax is withheld.³

Vesting. The point at which an employer’s contributions, or a pension benefit, become the employee’s to keep.²³

Cash balance plan. A defined benefit plan that states the promise as an account balance and allows a lump sum.²

Safe harbor. A 401(k) design that avoids yearly nondiscrimination tests by making fully vested employer contributions.³

Replacement rate. The share of working income a household’s retirement income replaces, the measure behind the risk index.⁶

The health coverage that arrives with retirement is the subject of the next entry.