Managing Institutional Investor Portfolios －LO

For defined contribution plans, investment risk is borne by the pension beneficiary. The plan sponsor, and frequently the plan participant, make defined contributions to the plan. The pension benefit to the participant is based on the pension funds investment performance.

Retirement benefits from a defined benefit plan are based on a "defined benefit" formula. This is what the company owes the plans participants, regardless of the performance of the pension funds assets, and if the funds returns fall short of the pension obligations, the plan sponsor is liable for the difference. Defined benefit plans are costlier and riskier than defined contribution plans. Thus, defined contribution plans are the preferred pension plan for most employers. Also, since plan contributions are transferable to other plans, defined contribution plans are attractive to many young employees.

All investment decisions are made by the plan sponsor, and all risk/return tradeoffs accrue to the sponsor. The benefits paid by a defined benefit plan are determined by a specified benefit formula, not by what was contributed to the plan.

All investment decisions of defined contribution assets are made by the participant, which dictates to whom plan asset risk/return tradeoffs accruethe participant. The benefit paid is determined by the value of the investment assets at retirement. The only requirement of the plan sponsor is the stated contribution made to the participants account.