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CFA Level II Exam · Employee Compensation: Post-Employment and Share-Based

Defined Contribution vs Defined Benefit Pension Plans

Updated 6 October 2026 · Fact-checked

In a defined contribution (DC) plan, the employer pays a set amount into the plan and the employee bears investment and longevity risk; the employer expenses only the contribution. In a defined benefit (DB) plan, the employer promises a future benefit, bears those risks, and reports a net pension asset or liability.

Understand Defined Contribution vs Defined Benefit Pension Plans

A post-employment plan is a promise to pay employees after they retire. The two main designs differ in what is fixed: the contribution or the benefit.

In a defined contribution (DC) plan, the employer agrees to put a set amount into an individual account for each employee, often a percentage of salary. The final retirement payout depends on how well the investments perform. So the employee bears investment risk. The employee also bears longevity risk, the chance of outliving the savings. The employer has no further obligation once the contribution is paid.

In a defined benefit (DB) plan, the employer promises a specific benefit, usually based on a formula such as years of service × final salary × an accrual rate. The employer funds the plan and must make up any shortfall. So the employer bears investment risk and longevity risk. If assets earn less than expected, or retirees live longer than assumed, the employer must contribute more.

This drives financial reporting. For a DC plan, the employer simply records pension expense equal to the contribution for the period. There is no pension asset or liability beyond any unpaid contribution. For a DB plan, the employer reports the funded status: the fair value of plan assets minus the present value of the defined benefit obligation (PBO). A shortfall is a net pension liability; a surplus is a net pension asset (subject to an asset ceiling under IFRS).

DB reporting needs estimates: discount rate, salary growth, mortality and expected return. Small changes in these can move the obligation a lot. That is why analysts care about DB plans and rarely worry about DC plans. Level II questions will often ask you to identify the plan type from a vignette and say who carries the risk and what appears on the statements.

Key formulas to remember

Funded status
Funded status = Fair value of plan assets − Present value of defined benefit obligation (PBO)
Negative = net pension liability (underfunded). Positive = net pension asset (overfunded), limited by the asset ceiling under IFRS. Applies to DB plans only.
DC plan expense
Pension expense = Employer contribution for the period
No obligation or asset beyond unpaid or prepaid contributions. Employee carries the risk.
Typical DB benefit formula
Annual pension = Years of service × Accrual rate × Final (or average) salary
Exact formula depends on the plan terms given in the vignette. Use the numbers supplied.

How to solve Defined Contribution vs Defined Benefit Pension Plans questions

Use this sequence for any DB vs DC question in a vignette.

  1. 1Read the plan description and ask what is fixed: the contribution (DC) or the promised benefit (DB).
  2. 2Name who bears investment risk and longevity risk: employee for DC, employer for DB.
  3. 3Check whether the question is about the balance sheet, the income statement or cash flow.
  4. 4For DC, set expense equal to the contribution made in the period and stop. No obligation is recognised.
  5. 5For DB, find plan assets and PBO in the exhibit and compute funded status = assets − PBO.
  6. 6Interpret the sign: negative is a net liability, positive is a net asset (note any asset ceiling).
  7. 7If the question involves a change in an assumption, remember that a lower discount rate raises PBO and lowers funded status.
  8. 8Match your answer to the exact wording of the option, especially who bears the risk.

Quickest way: Fixed-item test

When to use it: Use when a question only asks you to classify the plan or identify who bears risk.

  1. Find the fixed item: contribution means DC; promised benefit means DB.
  2. DC: risk sits with the employee, expense equals contribution.
  3. DB: risk sits with the employer, report assets minus PBO.
  4. If numbers are given for DB, compute assets − PBO and read the sign.

Common mistakes in Defined Contribution vs Defined Benefit Pension Plans

  • Saying the employer bears investment risk in a DC plan.

    The employer makes the payments, so students assume it carries the risk.

    Fix: Ask who gets the shortfall. In DC the employee's account balance falls; the employer owes nothing more.

  • Recording a pension liability for a DC plan.

    Students apply DB logic to every plan.

    Fix: For DC, recognise only the contribution as expense. A liability appears only for an unpaid contribution.

  • Computing funded status as PBO minus plan assets and reading the sign backwards.

    The order of subtraction is easy to reverse under time pressure.

    Fix: Always use assets − PBO. Negative means underfunded, a net liability.

  • Thinking a DB plan's expense equals the cash contribution.

    This is true for DC, so it gets carried over.

    Fix: DB expense comes from service cost, interest on the obligation and related items, not from cash paid. Contributions affect plan assets.

  • Ignoring longevity risk and mentioning only investment risk.

    Investment risk is the more familiar idea.

    Fix: State both. DB employer bears both; DC employee bears both.

Worked examples

Example 1

Vignette: Arden Industries, an IFRS reporter, offers a plan where it pays 8% of each employee's salary into individual investment accounts each year. Employees choose the investments and receive whatever the account is worth at retirement. Total salaries this year were €50 million and Arden paid the full 8%. Q1: Classify the plan and say who bears investment risk. Q2: What pension expense does Arden report for the year, and does it record a net pension liability?

Show the solution
  1. Q1: The contribution (8% of salary) is fixed and the final benefit varies with investment results. This is a defined contribution plan.
  2. Employees choose investments and receive the account value, so employees bear investment risk and longevity risk.
  3. Q2: Expense = contribution = 8% × €50 million = €4 million.
  4. Arden paid the full amount, so there is no unpaid contribution and no net pension liability.

Answer: Q1: DC plan; employees bear investment risk. Q2: Pension expense is €4 million and no net pension liability is recorded.

Example 2

Vignette: Borrowdale Corp, an IFRS reporter, promises retirees an annual pension of 1.5% of final salary for each year of service. At year-end, the fair value of plan assets is £820 million and the present value of the defined benefit obligation is £950 million. Q1: Who bears investment and longevity risk? Q2: What is the funded status and how is it reported? Q3: If the discount rate used to value the obligation falls, what is the likely effect on funded status, other things equal?

Show the solution
  1. Q1: The benefit is promised and based on a formula, so this is a DB plan. The employer bears investment risk and longevity risk.
  2. Q2: Funded status = 820 − 950 = −£130 million.
  3. A negative result means the plan is underfunded, so Borrowdale reports a net pension liability of £130 million.
  4. Q3: A lower discount rate increases the present value of the obligation. Assets are unchanged, so assets − PBO becomes more negative, and funded status worsens.

Answer: Q1: Employer bears both risks. Q2: Funded status is −£130 million, reported as a net pension liability. Q3: Funded status worsens because the PBO rises.

Exam tips

  • Identify what is fixed before reading the options. It settles most classification questions quickly.
  • In DB numeric questions, extract plan assets and PBO from the exhibit, ignoring other figures such as contributions or benefits paid unless asked.
  • Questions often disguise a DC plan as employer-friendly. Look for phrases like 'employee selects investments' or 'account balance'.
  • When an assumption changes, reason about direction first: lower discount rate raises PBO, higher salary growth raises PBO.
  • Remember IFRS and US GAAP differ in DB cost recognition, so check which framework the vignette uses before answering cost questions.

Defined Contribution vs Defined Benefit Pension Plans in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Defined Contribution vs Defined Benefit Pension Plans: frequently asked questions

What is the main difference between a DC and a DB plan?

In a DC plan the employer's contribution is fixed and the retirement benefit varies. In a DB plan the retirement benefit is promised and the employer's required funding varies. This decides who bears risk and how it is reported.

Who bears the risk in a defined benefit pension plan?

The employer bears both investment risk and longevity risk. If plan assets underperform or retirees live longer than assumed, the employer must fund the shortfall.

How does the employer report a DC plan?

It records pension expense equal to the contribution for the period. No pension asset or liability is recognised, other than any unpaid or prepaid contribution.

How do you compute funded status for a DB plan?

Funded status is the fair value of plan assets minus the present value of the defined benefit obligation. A negative result is a net pension liability, and a positive result is a net pension asset, subject to the IFRS asset ceiling.