Describe the differences in funding risk between defined benefit and defined contribution plans.

• A. Defined benefit promises a retirement payout funded by the employer; funding risk falls on the sponsor.
• B. Defined benefit specifies contributions by the employer/employee; investment risk falls on the employee.
• C. Defined benefit has no funding risk
• D. Defined contribution guarantees a fixed payout

Answer: (A)

Funding risk is about who must ensure promised retirement benefits are funded. In a defined benefit plan, the plan promises a specific payout based on a formula (often tied to salary and years of service). The sponsor is responsible for supplying enough funds to meet that promise, so if investments underperform or life expectancy rises, the sponsor must contribute more to cover the shortfall. That’s why the risk rests with the employer or plan sponsor.

In a defined contribution plan, the contributions are defined, but the payout depends on how the investments perform and how much is contributed over time. The employee bears the investment risk because the retirement income isn’t guaranteed and flips with those investment results. The sponsor’s role is mainly to make the prescribed contributions.

So the best description is that a defined benefit plan promises a retirement payout funded by the employer, with funding risk borne by the sponsor. The other statements misstate who bears the risk or the nature of the payout.