defined benefit (DB) vs defined contribution (DC)
/ DB = "D-B"; DC = "D-C" /
There are two fundamentally different ways to promise a pension, and the difference is about who carries the risk. In a defined-benefit (DB) plan the benefit is promised — for example, a pension of 1.5% of final salary for each year worked. In a defined-contribution (DC) plan only the contribution is fixed — a set percentage of pay goes into your personal account — and your eventual pension is whatever that account, after investment ups and downs, can buy.
Under DB, the employer bears the investment and longevity risk: if returns are poor or members live longer than expected, the employer must put in more to honour the promise. Your benefit is a known formula, like years of service times an accrual rate times final salary. Under DC, you bear the risk: your account might grow well or badly, and at retirement you must decide how to turn the balance into income (a key reason the annuity puzzle matters). A 30-year career might give a DB member a pension of 45% of final salary, guaranteed; a DC member with the same contributions gets a pot whose value is uncertain.
Globally there has been a vast shift from DB to DC, because DB promises proved expensive and risky for employers as people lived longer and markets fluctuated. For actuaries this changes the work: DB plans need complex funding valuations of the promised liability, while DC plans need help with contribution design, default investments, and converting accounts into retirement income. The honest caveat: 'DC is cheaper' is true mainly because the risk has been transferred to individuals, who are generally far less able to bear longevity and market risk than a large employer or the state.
Two colleagues retire after 30 years. Anna's DB plan guarantees 45% of her final salary for life — predictable, the employer's problem if markets dropped. Ben's DC account grew through good and bad markets to 600,000; he must now decide how much to spend each year or whether to buy an annuity, and a market crash just before he retired would have cut his pension directly. Same career, very different certainty.
DB: the benefit is promised, employer bears risk. DC: the contribution is fixed, you bear risk.
DC plans look 'safer' for the sponsor only because the longevity and investment risk has been moved onto individuals — who usually have far less capacity to absorb a bad market or an unexpectedly long life.