Retirement plan types may vary by employer

Betty J. Neal is a certified financial planner and investment representative for Edward Jones Investments.

All retirement plans are not created equal. In fact, they can be quite different. So it's important to understand which type of plan an employer is offering, and what to expect from it now and at retirement.

To begin with, retirement plans come in two main varieties: defined benefit plans and defined contribution plans.

If the employer has a 40l(k) plan or a 403(b) plan for teachers or a 457 plan for state or municipal employees it is a defined contribution plan. In this arrangement, investors may choose to defer some of their salary, which they then spread among the available investment options. The money grows on a tax-deferred basis until the investor starts making withdrawals, usually at retirement.

To some extent, a defined contribution plan lets investors control their own destiny. They pick the investments that match their goals and tolerance for risk. If investors do a good job, they'll accumulate a substantial amount of money to help pay for retirement. But this freedom to invest also can work against investors. If they make poor choices, or if they don't properly diversify the retirement plan portfolio, the investor may be disappointed when it's time to start taking money out.

The situation is considerably different in a defined benefit plan, such as a pension plan. If investors participate in this type of plan, they'll receive, upon retirement, a specific amount of money based on salary history and years of service. In many defined benefit plans, should an employee leave before retirement age, the employee will not receive any benefit, or will receive a reduced amount that can't be touched until retirement age. Many of these plans don't allow lump-sum distributions, so investors will receive a set monthly amount in retirement.

With a defined benefit plan, investors have to depend on the employer to make the right moves on their behalf. But that may not be as unsettling as it sounds, because companies that fund pension plans have traditionally based their contributions on a fairly conservative formula that has been pegged to the yield on U.S. Treasury bonds. A watchdog agency, the Pension Benefit Guaranty Corporation, also ensures that pensions are adequately funded.

However, in the past couple of years, as yields on treasuries have plunged, plan sponsors have been required to set aside much more of their money to meet their pension obligations. This predicament could eventually lead to cost-cutting measures, including benefit reductions, freezes or plan terminations. To ward off this problem, business lobbyists have asked Congress to liberalize the rules governing pension contributions.

There are no sure things in either a defined contribution plan or a defined benefit plan. That's why investors need to make well-informed decisions.

Also, don't count on any one plan to fund retirement entirely. Instead, build up other savings and investments. The more investors put in today, the better off they're likely to be tomorrow.