There are two major types of pension plans in the United States. One is defined benefit plan and the other is defined contribution plan.
Defined benefit plan
Defined benefit plan is the most common pension plan in the United States, covering nearly 90% of public employees and 10% of private employees. Defined benefit plan requires employers to give their workers a regular and definite payment after their retirement no matter how well or how poorly the investment fund performs. If the company’s investment fund is performing well, it can certainly cover the whole payment, and employers may have money left; if the investment fund is performing poorly, employers should cover the remaining payment. The amount of payment is determined by employees’ earnings and their length of service.
Defined contribution plan
Although defined benefit plan is more common, defined contribution plan costs less than the former one, attracting more and more private companies to move to this type of pension plan. The best-known defined contribution plan is 401(k), and for non-profits’ workers, it is 403(b).
Defined contribution plan greatly reduces employers’ financial burden and their work. All they need to do is to contribute certain amount of money into the investment fund and the amount they pay is based on the contribution the workers have made to the company. The eventual benefit that employers receive is determined by the performance of the investment fund.
Some companies offer both defined contribution plan and defined benefit plan, thus their employees can participants in both plans to maximize their future benefit.
Pay-as-you-go plan is a variation of the two plans listed above. It is created by employers but fund entirely by employees. Employees may prefer this option if they wish to deduct their salary or lump sum contribution which are not allowed by 401(k). Note that pay-as-you-go plan does not offer company match.