Defined Contribution Plan
A retirement plan where the employer and/or employee contribute a fixed amount to individual investment accounts (like a 401k or 457b), with no guaranteed benefit amount.
How It Works
In a defined contribution (DC) plan, the employer deposits a fixed amount (typically 4-10% of salary) into an individual investment account for each employee, often matched by employee contributions. The employee bears all investment risk: retirement income depends entirely on investment performance and contribution levels over the working career. Common vehicles for governmental DC plans include IRC Section 401(a) money purchase plans, Section 457(b) deferred compensation plans (the governmental equivalent of 401(k)s), and 403(b) plans for school districts. Michigan closed its state employee DB plan to new hires in 1997 and moved them to a DC plan, saving an estimated $4-5 billion in long-term liability accumulation over two decades. Alaska made the same transition in 2006. Utah adopted a hybrid in 2011 after 2008 investment losses exposed its DB underfunding. From the city's perspective, DC plans eliminate investment and longevity risk: contributions are fully expensed each year, and there is no unfunded liability accumulation. This makes fiscal planning more predictable and protects future budgets from market volatility. Critics (including the National Institute on Retirement Security and the Center for Retirement Research at Boston College) argue DC plans produce worse outcomes for workers because they lack the risk-pooling of DB plans, often feature lower contribution rates than the full actuarial cost of equivalent DB benefits, and face high fees and poor investment decisions by individual participants. DC-only public plans are still rare (fewer than 5% of public workers) because public employee unions and state constitutional protections generally preserve DB plans for existing employees. DC plan prevalence affects the long-term trajectory of the 20% pension funding factor in the CitySpend Fiscal Health Score.
Related Terms
- Defined Benefit Pension, A retirement plan where the employer guarantees a specific monthly payment for life based on years of service and final salary, the traditional government pension.
- Hybrid Pension Plan, A retirement plan that combines elements of a defined benefit pension (guaranteed minimum) with a defined contribution component (individual investment accounts).
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About This Definition
This definition is part of the CitySpend Municipal Finance Glossary, 59 terms explaining how city governments fund and manage public services. All definitions are written in plain language for taxpayers, journalists, students, and municipal bond investors.