There are two types of pension programs defined benefit plans and defined contribution plans. From the workers point of view, the plan consists of a promised benefit formula and a lack of investment risk. The employer s promise is limited to this funding amount. In contrast to participants in DB plans, DC plan participants bear the risk of the returns of the assets in the plan. They have become increasingly popular, not only because of their relative administrative simplicity but also because of their flexibility in terms of asset allocation.
People can choose to invest at the ratio of risk to return that they are comfortable with.
Social Security is a defined benefit plan. It has a particularly complicated formula for determining monthly benefits based on earnings history, age of retirement, and marital status. Each year most workers contributions are immediately paid to retirees rather than being invested in financial assets to provide for future benefits. Such a system is illegal for private employers but feasible for governments because they have the ability to fund promises with taxes on future workers. In survey after survey, working Americans express skepticism about Social Security s ability to pay them benefits when they retire.