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Googling "State pension plan" I get the result as shown here: http://www.direct.gov.uk/en/Pensionsandretirementplanning/StatePension/index.htm. As described on the webpage, "Once you claim your State Pension, it gives you a regular income for the rest of your life. It can give you a reliable foundation for your income in retirement, although it might not be enough to support the lifestyle you want. So you may decide you want to save for yourself on top of what the State provides."

Googling "Defined contribution plan" I get the following description by Investopedia: "A retirement plan in which a certain amount or percentage of money is set aside each year by a company for the benefit of the employee. (...) "

So basically it seems to me that these are related, but I don't see if there exists a difference and what that difference is.

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The specific "State Pension" plan you have linked to is provided by the government of the U.K. to workers resident there.

More generally speaking, many countries provide some kind of basic worker's pension (or "social security") to residents. In the United States, it is called (surprise!) "Social Security", and in Canada most of us call ours "Canada Pension Plan". Such pensions are typically funded by payroll deductions distinct & separate from income tax deducted at source. You can learn about the variety of social security programs around the world courtesy of the U.S. Social Security Administration's own survey.

What those and many other government or state pensions have in common, and the term or concept that I think you are looking for, is that they are typically defined benefit type of plans. A defined benefit or DB plan is where there is a promised (or "defined") benefit, i.e. a set lump sum amount (such as with a "cash balance" type of DB plan) or income per year in retirement (more typical).

  • Key point: With a DB plan, the organization offering the plan is on the hook to deliver the defined amount(s) at retirement, and is therefore taking on the risk of how the invested funds perform in the meanwhile, because they'll need to make up any shortfall, if any.

(Note: Defined benefit plans are not restricted to be offered by governments only. Many companies also offer DB plans to their employees, but DB plans in the private sector are becoming more rare due to the funding risk inherent in making such a long-term promise to employees.)

Whereas a defined contribution or DC plan is one where employee and/or employer put money into a retirement account, the balance of which is invested in a selection of funds. Then, at retirement the resulting lump sum amount or annual income amounts (if the resulting balance is annuitized) are based on the performance of the investments selected.

That is, with a DC plan, there is no promise of you getting either a set lump sum amount or a set amount of annual income at retirement! The promise was up front, on how much money they would contribute. So, the contributions are defined (often according to a matching contribution scheme), yet the resulting benefit itself is not defined (i.e. promised.)

  • Key point: With a DC plan, if investments perform poorly, you get less at retirement. You are taking on the risk of investment underperformance.

Summary:

DB plans promise you the money (the benefit) you'll get at retirement.
DC plans only promise you the money (the contributions) you get now.

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  • 1
    Great answer. I would add that Social Security/National Insurance plans are mandatory (I'm sure its true for the Canadian version as well). – littleadv Sep 24 '12 at 21:46
  • Yes great answer, I would also just add that DB plans are worked out by a set formula based on the length of employment service and will be a percentage of the employee's final salary just before retirement. So the longer the employment service period the higher the percentage of final salary will be up to a maximum percentage. – Victor Sep 24 '12 at 23:58
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    +1 Great answer indeed. I will add a little to @littleadv's comment that Social Security is mandatory. In the US, state governments can opt to not have state employees participate in Social Security if the state provides an equivalent plan. As an example, State of Illinois employees don't pay Social Security taxes but are instead covered by State-administered retirement plans (different ones for different groups such as state universities, judges, legislators, etc). People who began work before 1986 don't pay Medicare tax either; newer hires do. Used to be DB plan, but is changing to DC plan. – Dilip Sarwate Sep 25 '12 at 1:29
  • To continue my previous comment, State of Illinois employees don't get Social Security benefits and are not covered by Medicare unless they have 40 quarters of other service (other employment before or after State service, self-employment during State service, etc) with wages subject to SS and Medicare tax (or qualify as a spouse of someone covered by SS and Medicare. Furthermore, the Windfall Elimination Provision rule reduces the Social Security Benefit for those who receive a pension based on wages not subject to Social Security and Medicare tax. – Dilip Sarwate Sep 25 '12 at 1:38
  • @Victor The formulas to calculate DB plan benefits vary widely. But in general, yes, many DB plans are based on some function of service and salary history. I've seen final average earnings plans, career average earnings plans, and weird plans. Many actual plans combine more than one method, because plan rules or accrual rates may have changed at some point and service accrued prior to a change are calculated the old way, and newer service calculated the new way. Then there are reduction/increase factors for early/late retirement, and those vary widely too. DB plan logic can be very complex. – Chris W. Rea Sep 25 '12 at 2:33

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