Defined Benefit vs Defined Contribution Pensions

Two employees can both have "a pension" and be exposed to completely different risks. In a defined benefit (DB) plan, the employer promises a specific payout in retirement — often calculated from years of service and final salary, like "2% of final salary per year worked" — and is on the hook to deliver it regardless of how the fund's investments perform. In a defined contribution (DC) plan, the employer instead promises a specific contribution each year into the employee's own investment account, and whatever that account grows to (or shrinks to) is what the employee retires on. The name describes what's fixed: in DB, the benefit is fixed; in DC, the contribution is fixed.

Who bears the risk

This single difference in wording hides a total reversal of who bears investment, longevity, and inflation risk. Under DB, if the stock market has a bad decade, or retirees simply live longer than the actuaries assumed, the employer's pension fund has to make up the shortfall — the promised payout doesn't change. Under DC, if the market has a bad decade right before someone retires, that's the employee's problem: their account balance is whatever it is, and it converts directly into a smaller retirement income. DB pools risk across a large number of employees and across time, run by professional investment managers; DC pushes that same risk down to each individual, who often has far less capacity and expertise to manage it.

Why the world shifted from DB to DC

Through the second half of the twentieth century most large employers ran DB plans. Since the 1980s, most private-sector employers in the US and UK have closed their DB plans to new members and shifted new hires to DC instead. The reasons are almost entirely about the employer's balance sheet, not employee welfare: a DB promise is an open-ended, long-dated liability that shows up on the company's books and can swing wildly in reported value as interest rates and markets move, while a DC contribution is a fixed, predictable annual expense with no ongoing tail risk once it's paid. Rising life expectancy also made DB promises steadily more expensive to keep, since "pay X per year until death" gets costlier every time actuaries revise mortality assumptions downward.

For example, a worker who spends 30 years at a firm with a DB plan promising 1.5% of final salary per year of service retires with a pension fixed at 45% of final salary, paid for life, regardless of what happened to markets during those 30 years. A worker at a DC-only firm who contributed the same dollars into an account invested in equities and bonds could retire with meaningfully more or less than that 45% figure, purely depending on market timing around their retirement date — a risk the DB worker never carried.