Developing a Policy for Retirement Plan Design Options

The retirement benefit is a form of compensation designed to assist the employer in the recruitment and retention of public employees and other workforce management goals. It is also provided to assist employees in preparing for retirement and compensate individuals for their years in public service. 

In developing a policy for retirement plan design, a state or local government should consider the following: 

1. Purpose of the retirement plan (e.g., level of replacement income, availability of Social Security, retiree medical benefits, disability and survivor benefits, supplemental retirement plans, and purchasing power retention); 
2. The sufficiency of the benefits to contribute to a meaningful retirement income; 
3. Philosophy regarding plan sponsor and participant responsibilities in preparing for retirement; 
4. Ability of plan sponsor to sustain contribution payments over time and through various economic cycles; 
5. Labor market considerations such as competitive environment, workforce mobility, length of employee service, and recruitment and retention of employees, including compliance with collective bargaining agreements; 
6. Investment risk and control, including how investment risk and fees are allocated between plan sponsor and participant; 
7. Portability of benefits; 
8. A plan design that can be communicated to and understood by plan participants; 
9. Required participant education;  
10. Advantages of the different types of plans (e.g., defined benefit, defined contribution, and hybrid); 
11. The complexity and efficiency of administering the plan; and 
12. Compliance with legal and regulatory requirements. 

Broadly speaking, there are two types of retirement plans, defined benefit and defined contribution. These two types of plans are discussed below. 

Defined Benefit Plans. Defined benefit plans, with very few exceptions, provide a retirement benefit calculated using a formula based upon a plan participant’s years of service and compensation. Generally, both employers and participants contribute to public sector defined benefit plans. All assets accumulated to fund the retirement benefits are invested by the retirement board or a central government agency responsible for investing pension funds. All investment-related risk is generally borne by the plan sponsor. These plans are more prevalent in the public sector. 

Defined Contribution Plans. A defined contribution plan provides for benefits based solely on the assets available in an employee's individual account, to which both employees and employers may contribute. All employees have their own accounts set up within the plan to which contributions and investment gains and losses are recorded. Typically, employees direct the investment of their contributions among investment options selected by plan trustees, the employer or the employer’s designated agent and therefore employees fully bear the investment risk. The dollar amount accumulated in a defined contribution plan will vary depending upon the amount contributed to the plan, the investment performance, and the fees paid. 

Program features, benefits and risks of the two plan types are compared in the table below. 

In addition to defined benefit and defined contribution plans, some entities provide retirement benefits through hybrid plans that incorporate features of both defined benefit and defined contribution plans. 

Neither defined benefit plans nor defined contribution plans are inherently more expensive. Design choices regarding the magnitude of benefits or contributions and the allocation of costs between the plan sponsor and participants determine the actual costs of either type of plan. 

Updated: January 2025