DC and DB — The Difference Is Responsibility, Not Risk

Participants need to know this difference

Often, discussions differentiating defined contribution plans and defined benefit plans focus on who bears the risk. It is said that in a defined contribution plan the risk bearer is the participant, and the company shoulders the risk in a traditional pension plan. I disagree. 

Nothing is risk-free. Usually these DC/DB discussions outline in detail the risk for those working at companies that offer a defined contribution retirement program. Seldom is the conversation balanced with a list of events and decisions that could reduce or even eliminate an expected defined benefit outcome. Participants in both programs are exposed to risk. However, the programs differ fundamentally in another way. 

The difference is who bears responsibility for the outcome. In a defined benefit plan, the employer is responsible for delivering a specific, pre-determined retirement outcome. Participants do not need to know or do anything. In contrast, participants in a defined contribution program are ultimately responsible for their own financial security in retirement. Employers play a critical role in helping the defined contribution participant succeed, but an employer sponsoring a defined contribution plan is never responsible for a future outcome. 

A defined contribution arrangement is a partnership. Working together, the company and the employee build the personal wealth necessary to finance a dignified retirement experience. For example, nearly 90 percent of defined contribution plan participants are given an opportunity to set aside a portion of their own wages in an employer-provided defined contribution plan. 

Understanding this responsibility is important as employers move to take a more active role in their defined contribution programs. I have already been asked whether or not plan communications and education can be cut back if an employer implements automatic en rollment. My answer is, not necessarily. 

Participants who understand how their plans works, and why it works that way, are more likely to appreciate the plan’s value and less likely to opt out of the plan either initially or at some future date. They also will be better able to make the decisions necessary to properly manage their accumulated retirement wealth as they change jobs and during retirement itself. 

Further, the participant’s responsibility for financial security in retirement should be made clear to them. If they understand that they and not their employer are ultimately responsible, they will be more willing to take advantage of what their employer offers and more grateful for what their employer provides. 

Defined contribution plans are fundamentally different from defined benefit plans, but not because one has risk and the other is risk-free. The difference is who bears responsibility for the outcome. It is critical that employees not be mislead about this as we move to what some are calling “the DB-ing of the DC system.”