Employer-sponsored pensions fall into two major categories: defined benefit (DB) and defined contribution (DC) plans. In DB, or traditional, plans, benefits are typically set by formula, with workers receiving benefits upon retirement based on the number of years worked for a firm and earnings in years prior to retirement. In DC plans, workers accumulate savings through contributions to an individual account. These accounts are tax-advantaged in that contributions are typically excluded from current income, and earnings on balances grow tax-deferred until they are withdrawn. An employer may also make contributions, either by matching employee’s contributions up to plan or legal limits, or on a non- contingent basis. Like DB plans, DC plans operate in a voluntary system with tax incentives for employers to offer a plan and for employees to participate. Contributions to and earnings on DC plan accounts are not taxed until the participant withdraws the money, although participants making withdrawals prior to age 59 ½ may incur an additional 10 percent tax. In 2006, the pension tax expenditure for DC plans amounted to $54 billion. In addition, a nonrefundable tax credit to qualifying low-and middle-income workers who make contributions, the saver’s credit, accounted for less than 2 percent of the 2006 tax expenditure on account-based retirement plans. DC plans offer workers more control over their retirement asset management, but also shift some of the responsibility and certain risks onto workers. Workers generally must elect to participate in a plan and make regular contributions into their plans over their careers. Participants typically choose how to invest plan assets from a range of options provided under their plan, and accordingly face investment risk. Savings in DC plans are portable in the sense that a participant may keep plan balances in a tax-protected account upon leaving a job, either by rolling over plan balances into a new plan or an IRA, or in some cases leaving money in an old plan. Workers may have access to plan savings prior to retirement, either through loans or withdrawals; participants may find such features desirable, but pre-retirement access may also lead to lower retirement savings (sometimes referred to as leakage) and possible tax penalties. Workers who receive DC distributions in lump-sum form must manage account withdrawals such that their savings last throughout retirement. In contrast, a formula, often based on preretirement average pay and years of service, determines DB plan benefits, and workers are usually automatically enrolled in a plan. The employer has the responsibility to ensure that the plan has sufficient funding to pay promised benefits, although the sponsor can choose to terminate the plan. DB plans also typically offer the option to take benefits as a lifetime annuity, or periodic benefits until death. An annuity provides longevity insurance against outliving one’s savings, but may lose purchasing power if benefits do not rise with inflation. Table 1 summarizes some of the primary differences between DC and DB plans. Over the past 25 years, DC plans have become the dominant type of private sector employee pension. In 1980, private DB plans had 38 million participants, while DC plans had 20 million. As of 2004, 64.6 million participants had DC plans, while 41.7 million had DB plans. Further, over 80 percent of private sector DC participants in 2004 were active participants (in a plan with their current employer), while about half of DB participants had separated from their sponsoring employer or retired. According to the Employee Benefit Research Institute (EBRI), while overall pension coverage among families remained around 40 percent between 1992 and 2001, 38 percent of families with a pension relied exclusively on a DC plan for retirement coverage in 1992, while 62 percent had a DB plan. In 2001, 58 percent of pension-participating families had only a DC plan, while 42 percent had a DB plan. Assets in all DB plans exceeded total DC assets as recently as 1995. As of 2006, DC plans had almost $3.3 trillion in assets while DB plans had almost $2.3 trillion. In addition, assets in IRAs, accounts that are also tax protected and include assets from rolled-over balances from employer-sponsored plans, measured over $4.2 trillion in 2006. There are several different categories of DC plans. Most of these plans are types of cash or deferred arrangements (CODA), in which employees can direct pre-tax dollars, along with any employer contributions, into an account, with assets growing tax deferred until withdrawal. The 401(k) plan is the most common, covering over 85 percent of active DC participants. Certain types of tax-exempt employers may offer plans, such as 403(b) or 457 plans, which have many features similar to 401(k) plans. Many employers match employee contributions, generally based on a specified percentage of the employee’s salary and the rate at which the participant contributes. Small business owners may offer employees a Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) or a Simplified Employee Pension Plan (SEP), two types of DC plans that have reduced regulatory requirements for sponsors. Other types of DC plans keep the basic individual account structure of the 401(k), but with different requirements and employer practices. Some are designed primarily for employer contributions. These include money purchase plans, which specify fixed annual employer contributions; profit sharing plans, in which the employer decides annual contributions, perhaps based on profits, into the plan, and allocations of these to each participant; and employee stock ownership plans (ESOPs), in which contributions are primarily invested in company stock. Building up retirement savings in DC plans rests on factors that are, to some degree, outside of the control of the individual worker, as well as behaviors an individual does control (see fig. 1). Factors outside the individual’s direct control include the following: Plan sponsorship—the employer’s decision to sponsor a plan, as well as participation eligibility rules. Employer contributions—whether the sponsor makes matching or noncontingent contributions. Investment options—the plan sponsor’s decisions about investment options to offer to participants under the plan. Market returns on plan assets—market performance of plan assets. Key individual decisions and behaviors that may affect retirement savings include the following: Employee contributions—deposits into the plan account, typically out of current wages. Investment decisions—how to invest plan assets given investment options offered under the plan. balances, which usually incur a tax penalty. Similarly, taking out a loan from a plan, if allowed, may reduce future balances if the loan is not repaid in full and treated as a withdrawal, or by lowering investment returns. Rollover—upon separation from a job, a participant may transfer the plan account balance to an IRA, which maintains most of the same tax preferences on the balances, move it to a new tax-qualified plan, or leave the money in the old plan. Alternatively, any cash withdrawal would likely be subject to income tax and penalties. Age at retirement—the decision as to when to retire determines how many years the worker has to accumulate plan balances and how long the money has to last in retirement. There is little consensus about how much constitutes “enough” savings to have going into retirement. We may define retirement income adequacy relative to a standard of minimum needs, such as the poverty rate, or to the consumption spending that households experienced during working years. Some economists and financial advisors consider retirement income adequate if the ratio of retirement income to pre-retirement income—or replacement rate—is between 65 and 85 percent. Retirees may not need 100 percent of pre-retirement income to maintain living standards for several reasons. Retirees will no longer need to save for retirement, retirees’ payroll and income tax liability will likely fall, work expenses will no longer be required, and mortgages and children’s education and other costs may have been paid off. However, some researchers cite uncertainties about future health care costs and future Social Security benefit levels as reasons to suggest that a higher replacement rate, perhaps above 100 percent or higher, would be considered adequate. To achieve adequate replacement rate levels, retirees depend on different sources of income to support themselves in retirement. Social Security benefits provide the bulk of retirement benefits for most households. As of 2004, annuitized pension benefits provided almost 20 percent of total income to households with someone age 65 or older, while Social Security benefits provided 39 percent. Social Security benefits compose over 50 percent of total income for two-thirds of households with someone age 65 or older, and at least 90 percent of income for one-third of such households. Table 2 shows estimated replacement rates from Social Security benefits for low and high earners retiring in 2007 and 2055, as well as the remaining amount of pre-retirement income necessary to achieve a 75 percent replacement rate. These figures give rough guidelines for how much retirement income workers might need from other sources, such as employer-sponsored pensions, as well as earnings and income from other savings or assets. It is important to keep certain economic principles in mind when evaluating the effectiveness of retirement accounts, or any pensions, in providing retirement income security. First, balances accumulated in a DC plan may not represent new saving; individuals may have saved in another type of account in the absence of a DC plan or its tax preferences. Second, evaluating worker income security should consider total compensation, not just employer contributions to DC plans. All else equal, we should generally expect more generous employer-sponsored pension benefits to lower cash wages and that the split between current wages and deferred compensation is largely a reflection of labor market conditions, tax provisions, and worker and employer preferences. Many workers do not have DC plans, and median savings levels among participants show modest balances. While it is worth noting that for workers nearing retirement age, DC plans were not considered primary pension plans for a significant portion of their working careers, participation rates and median balances in such plans are low across all ages. Only 36 percent of working individuals were actively participating in a DC plan, according to data from the 2004 SCF.