Broadly, there are two types of retirement plans: defined benefit and defined contribution.
A defined benefit plan is one in which retirees know in advance what their benefits will be. Such pension benefits are defined based on the number of years an employee has been employed by the organization and her salary history. Qualification for these plans requires long-term commitment to an employer, often on the order of ten years. Once eligible, an employee is promised a steady pension income stream in retirement. The employer is responsible for investment decisions made within the plan.
Defined contribution plans place responsibility for retirement investing decisions directly on the shoulders of employees. Employees decide how much they want to contribute to their retirement plan and bear responsibility for the results. The plan does not guarantee benefits. 401(k) and 403(b) accounts are defined contribution plans, in which the employee decides what her contributions will be each year. Employers may contribute some matching funds to employees’ plans. At retirement, employees begin withdrawing the funds that have accumulated in their plans. The total accumulated in an employee’s fund depends entirely on the employee’s investing decisions. If investments turn out to be unsuccessful, there’s less available to that employee in retirement. The employer bears no responsibility for the investment choices made by employees.
Decades ago, America’s largest companies offered extremely generous versions of these defined benefit pension plans. But such plans proved very expensive to maintain and the resulting obligations brought many firms near, or all the way to, bankruptcy. For this reason many organizations have greatly scaled back or ended defined benefit plans in favor of defined contribution plans.
Defined benefit plans are making somewhat of a comeback within private medical practices, as under some circumstances such plans may allow significantly larger retirement contributions than the often-used Solo 401(k) accounts. If you own a private practice you should discuss this with your licensed accountant.