Companies offer qualified retirement plans for various reasons. There are three main types of employer-qualified retirement plans: defined-benefit plans, defined-contribution plans, and salary-reduction plans. Defined-benefit plans provide a predetermined payout based on specific employee data, such as years of employment and annual salary. Defined-contribution plans are investment plans in which both the employee and the employer contribute funds to the plan; the amount contributed by the employer is generally fixed. Salary-reduction plans are plans in which employees contribute a percentage of their salary to retirement vehicles each period.

A defined-benefit plan (DBP), also called a pension plan, is a retirement plan funded entirely by an employer; the employee does not contribute to this type of plan. At retirement, the employee is promised a specific payout amount that is calculated using a formula set by the company.

With a defined-contribution plan (DCP), your employer contributes a specific amount to your retirement plan while you are working; then, when you retire, your employer is absolved of any further responsibilities. In a defined-contribution plan, both you and your employer generally contribute to the fund. Your pension is determined by how much both you and your employer invest each year, how fast the investment grows, and how many years your investment is able to grow.

Now that you have completed this section, ask yourself the following questions:

1. Can you explain employer-sponsored retirement plans?
2. Can you explain defined-benefit plans?
3. Can you explain defined-contribution plans?