Some employers offer workers access to a retirement plan. In general, employer-sponsored retirement plans can take two forms: defined-benefit (DB) plans and defined-contribution (DC) plans.
Under a DB plan, workers receive a monthly benefit beginning at retirement based on average salary and the number of years worked for the employer. Private DB plans, unlike public pension plans, are typically funded solely by the employer.
With DC plans—tax-preferred savings accounts such as 401(k)s—workers can designate an amount to be set aside in a retirement account with each paycheck. Employers may choose to contribute as well.
Over the past few decades, the number of private sector DB plans has declined substantially while the number of DC plans has increased and now far surpasses DB plans. Despite the growth of savings in tax-preferred DC retirement accounts, the income they generate has not compensated fully for the loss of employer-provided traditional pensions.
The decline in the number of workers covered by traditional defined-benefit pensions and the growing importance of defined-contribution plans such as 401(k)s have heightened three types of retirement savings risk for those employees who have DC accounts. First, since 401(k) plans are voluntary, some people may not participate and therefore run the risk of not saving enough. Second, unlike participants in DB plans, people in 401(k)s face the risk of poor investment performance because of an economic downturn, high fees, or poor investment choices. Finally, 401(k) participants run the risk of outliving their retirement savings, particularly since there is no strong encouragement to convert savings into lifetime retirement income, and lump-sum cash-outs at retirement are common.