Overview
PBGC insures defined benefit pension plans, but not other types of more common retirement plans, like 401(k) plans. This resource will help you understand the major differences.
There are many different kinds of employer-sponsored retirement plans in the United States. Pension plans are just one type of retirement plan. PBGC works almost exclusively with pension plans.
The Office of the PBGC Participant and Plan Sponsor Advocate frequently hears from individuals who need help understanding actions PBGC has taken regarding their pension benefits because pension benefits work very differently from 401(k) and other types of retirement benefits.
This resource will help you understand the basic differences between pension benefits and 401(k) or other similar types of retirement benefits. An overview of all of the differences and technicalities could fill a textbook. The PBGC Office of the Advocate is providing this factsheet to help workers and retirees gain a basic understanding of PBGC actions and decisions and why defined benefit pension benefits are different from other retirement plans’ benefits.
Quick facts
- There are two main types of employer-sponsored retirement plans – defined benefit plans and defined contribution plans.
- PBGC works mainly with defined benefit plans, which are often thought of as the “traditional” pension plan. Cash balance plans are a type of defined benefit plan.
- There are many types of defined contribution plans; 401(k) plans, 403(b) plans, Employee Stock Ownership Plans (ESOPs), and profit-sharing plans are just a few of the types of defined contribution plans.
- Only defined benefit plans are insured by the Pension Benefit Guaranty Corporation, and PBGC only trustees (takes over benefit administration responsibilities) for defined benefit plans if they are unable to pay benefits.
- In a 401(k) plan, every plan participant has an individual account with a balance that changes with contributions and investment gains and losses. For this reason, the account could eventually run out of money. In a pension plan, a participant’s benefit is determined using a formula. There is a single fund shared by all of the plan’s participants. Although the single fund’s balance changes, the benefits promised to retirees do not.
- Retired 401(k) plan participants can take benefit distributions in any amount at any time, whereas retired pension plan participants most commonly receive a designated monthly amount every month unless the pension plan offers other, less standard forms of benefit.
- Federal law requires both types of plans to pay survivor benefits to the spouse of a participant who is married at the time of death unless the spouse waives that right, but defined contribution plans will pay survivor benefits to another designated beneficiary if the participant isn’t married. Many defined benefit plans will not. Additionally, survivor benefits under a 401(k) plan are whatever remains in the participant’s account after the participant dies. A defined benefit pension plan must provide surviving spouses the option to receive monthly benefits for life, though they are allowed to offer other options.
- Both 401(k) and pension benefits can be divided at divorce. A former spouse can also be awarded a survivor benefit under both plan types at divorce.
- For questions about 401(k) plans, contact the Employee Benefits Security Administration.
Further education
Defined benefit vs. defined contribution
There are two large categories of retirement benefits: defined benefit plans and defined contribution plans. “Defined benefit plan” is usually what is meant when people say “pension plan.” Note that cash balance plans are a type of pension plan and these also fall under the definition of “defined benefit plan.”
Any employer-sponsored retirement plan that isn’t a defined benefit plan is a defined contribution plan. This means that 401(k) plans are defined contribution plans, and so are other types of retirement plans that share certain features in common with 401(k) plans. Other common types of defined contribution plans include employee stock ownership plans (ESOPs), 401(a) plans, 403(b) plans and profit-sharing plans. Since there are so many different types of defined contribution plans, we’ll use “defined contribution” or “DC” going forward instead of “401(k).”
With the limited exception of its Missing Participants Program, PBGC does not work with defined contribution plans. If you need help related to a defined contribution plan, contact the Employee Benefits Security Administration (EBSA), a federal agency that is part of the U.S. Department of Labor. EBSA operates a hotline staffed by Benefits Advisors who assist members of the public who need assistance with retirement benefit issues. EBSA can be reached at (866) 444-3272 or contact them online.
How are benefit amounts determined?
Perhaps the largest difference between defined benefit plans (DB plans) and defined contribution plans (DC plans) is the way in which benefits are determined. Many other features that distinguish DB plans from DC plans stem from this one difference.
In a defined benefit plan, a participating individual’s benefit is determined using a benefit formula. Benefit formulas can vary by plan, but they usually take into consideration how long the individual worked in the types of employment covered by the plan. Benefit formulas, which are outlined in plan documents, may also take into consideration the individual’s final salary or average salary and other variables. When an individual is ready to retire, the plan will use the benefit formula to calculate how much that individual should receive on a monthly basis, because defined benefit plans are designed to provide monthly income for life. This is called an annuity.
A pension plan can offer various forms of benefit that might require additional calculations to convert the standard annuity benefit into a different form of benefit. For example a plan might allow one-time lump sum payments of the entire benefit, which will require the plan to calculate the benefit’s present lump sum amount (note: PBGC customers may choose to receive their benefit in one lump sum instead of monthly payments for life only if the plan terminated before 2024 and the value of the benefit is no more than $5,000, or the plan terminated in 2024 or later and the value of the benefit is no more than $7,000). Providing survivor benefits also requires additional calculations to account for additional payments to a second person after the benefit-earner dies, which may cause the amount the benefit-earner receives during their lifetime to go down.
While the present lump sum value of a person’s pension benefit may fluctuate because it is calculated using interest rates, the base calculation using the plan’s benefit formula never changes once the individual has stopped working in covered employment. These plans are referred to as “defined benefit” plans because the benefit itself is defined using a formula, and is not dependent on contributions. Rather, the employer(s) that sponsor the plan are responsible for contributing enough money into the plan fund and properly investing that money to ensure that the plan has enough money to pay all the benefits it owes. Federal law governs how a plan determines whether it has sufficient funding and when and how much a sponsoring employer must contribute.
In a defined contribution plan, each individual participating in the plan is assigned an account. Depending on the rules of the plan, the individual might contribute money into the account, the employer might contribute money into the account, or they might both contribute money into the account. That money is then invested and the value of the account is determined by what was contributed plus whatever it earned (or lost) through investments. This means that an individual’s benefit amount can fluctuate daily depending on how it’s invested. These plans are referred to as “defined contribution” plans because the amount contributed into the account is a large factor in determining the amount of the benefit.
Pooled fund vs. individual account
In a defined contribution plan, each participant receives an individual account. In a defined benefit plan, however, there is a single fund that is used to pay for all the benefits that the plan owes. Individuals in charge of administering the plan must ensure that the fund receives appropriate contributions and is properly invested so that it can pay benefits as they become due.
Defined benefit plans work this way because they are designed to pay benefits for life, but it is impossible to predict how long a retiree will live and how much money will be needed to pay their benefit. By including all participants together, defined benefit plans can use group data to more accurately estimate how much money is necessary to pay everyone in the plan. This approach shares many principles in common with life or health insurance.
Portability
Unless they are eligible to take a lump sum benefit distribution, participants in defined benefit plans who switch jobs cannot roll over their benefits into another plan or a vehicle like an IRA because they do not have an individual account, and their benefits are funded through a single fund that exists to pay benefits to all of the plan’s participants. Participants in a defined contribution plan who switch jobs may roll over their account balance into an IRA or another employer-sponsored defined contribution plan, though they do not have to.
Forms of benefit
Defined benefit plans are designed to provide each individual participant with monthly payments of a specific, predictable amount every month for life – this is called an annuity. Plans are legally required to offer this form of benefit but they can also offer other optional forms of benefit from which a participant can choose. The key to understanding forms of benefits is that a participant must always receive what they are entitled to receive according to the plan’s benefit formula. So a pension plan will first calculate the participant’s benefit using its benefit formula and then perform any calculations necessary to convert the benefit into a different form.
For example, some plans may offer one-time lump sum payments of the entire value of a person’s benefit. But, since it is impossible to predict how long a participant would live and how much that person would receive during their lifetime, plans have to perform complex calculations to determine the present lump sum value of a person’s lifetime annuity benefit. That calculation must take into consideration things like mortality rate assumptions and interest rates. While a person’s monthly annuity benefit under a plan formula doesn’t change over time, the present lump sum value of that benefit can fluctuate.
PBGC does not offer a lump sum form of benefit under the plans it administers (except in the case of benefits with a present lump sum value below $5,000 for plans terminated before 2024 or $7,000 for plans terminated after 2024), however it offers several other optional forms of benefit.
Learn about the forms of benefit PBGC offers.
Participants in defined contribution plans receive an individual account with an account balance that may fluctuate significantly over time. Participants can distribute or roll over money from their accounts at any time once they have left covered employment, though there may be tax consequences depending on the timing and nature of the distribution.
Survivor benefits
Defined benefit plans are legally required to have married participants elect a form of benefit that provides monthly survivor benefits to their spouse if they die (unless the spouse consents to a different form of benefit). In particular, they must provide a surviving spouse monthly payments for life that are equal to at least 50% of what the participant was receiving while alive. Plans will perform the calculations necessary to determine the amount of the survivor benefit and are allowed to reduce the participant’s monthly lifetime benefit payments to offset the additional survivor benefit payments. Plans may also offer forms of benefit that provide more generous survivor benefit payments, such as 75% or 100% monthly benefit payments.
Because these payments are typically made available to survivor beneficiaries for life, it can be extremely expensive to provide survivor benefits to the child of a participant, who may live for decades after the death of the participant. Likewise, it would be impossible to provide lifetime survivor benefits to a charitable institution that could continue to exist indefinitely. For this reason, federal law only requires defined benefit plans to provide survivor benefits to spouses. Most defined benefit plans do not offer survivor benefits to individuals who are not a spouse.
PBGC allows non-spouse beneficiaries to receive a survivor benefit when the participant elects a type of certain and continuous benefit. Learn about the forms of benefit PBGC offers.
Additionally, in a defined benefit plan, the form of benefit is determined when the participant begins receiving benefit payments and cannot be changed after that time. For this reason, a participant who gets married after benefit payments begin will not be able to elect a survivor benefit for their new spouse.
Since a defined contribution benefit is essentially the amount of money contained in a participant’s individual account, the benefit available to a surviving beneficiary is whatever money remains in the account after the participant’s death. While federal law requires plans to pay the survivor benefit to the spouse of any participant who is married at the time of death (unless the spouse consents to a different beneficiary), an unmarried participant can designate any beneficiary they want. This could be a parent, child, sibling, friend, other relative, or even a charity.
Benefits under both defined contribution plans and defined benefit plans can be divided at divorce, and survivor benefits under both plans can be given to a former spouse who has been given this right at divorce. To divide retirement benefits at divorce, however, the parties need to obtain a court order called a QDRO – or Qualified Domestic Relations Order. This order must be submitted to the retirement plan.
Insurance
Defined benefit plans are insured by PBGC. This is because individuals in pension plans are promised a specific amount of money in retirement based on their plans’ formulas. If a pension plan is unable to pay the benefits it owes because it has insufficient funding, PBGC will make sure those benefits are paid up to the limits of PBGC’s guarantee. Most people receiving benefits from PBGC are receiving 100% of what they are owed.
Defined contribution plans are not insured. This is because there is no promised benefit amount, so there isn’t anything to insure. It is generally understood that the benefit amount in an individual’s retirement account may fluctuate, sometimes significantly.