A defined-benefit plan, also known as a traditional or fixed pension, is one in which the employee receives a set amount every month for life after retiring. The amount received is usually determined by the highest salary earned, and by the employee's length of time in service. Pension benefits may even be extended to a spouse upon the death of the employee, and may be adjusted periodically for cost-of-living increases.

Defined-contribution plans, on the other hand, require that employees put their own funds into their own individual retirement accounts, such as a 401(k) or 403(b) tax-sheltered annuity plan, or a profit-sharing or stock option plan. Employers may also contribute to these accounts, typically in the form of matching contributions, and the combined contributions will then be invested. Should the investments lose value, all of the risk is shouldered by the employee because a specific dollar amount has not been promised at retirement by the employer.

As defined benefit plans are far more costly to employers than are defined-contribution plans, these are being phased out in most types of private industry. They are still fairly common in government agencies, however, as well as in the military and the field of public education. Historically, these types of professions have received significant retirement benefits to offset the fact that they tend to offer lower salaries than do similar positions in the private sector. The fact that defined-benefit plans are less portable than defined-contribution plans also helps to retain employees. The fixed pension provides an incentive to experienced employees to remain in these jobs for 20 to 30 years, rather than seeking more lucrative positions with other organizations.

For more information, see IRS Topic 424 – 401(k) Plans and the IRS Web site on 403(b) Tax-Sheltered Annuity Plans.