There are two types of retirement plans covered by the Employee Retirement Income Security Act (ERISA), defined benefit plans and defined contribution plans.

A defined benefit plan ensures that participants will get a certain monthly payment when they retire. The plan may specify that the promised benefit would be in the form of a certain financial amount, such as $100 per month upon retirement. A benefit may also be calculated by applying a formula to a plan that takes into account elements such as pay and service - for example, 1 percent of the average wage for the previous five years of work for every year of service with an employer.

The benefits in most classic defined benefit plans are secured by government insurance provided via the Pension Benefit Guaranty Corporation, subject to certain conditions (PBGC).

A defined contribution plan, on the other hand, does not guarantee a set amount of retirement benefits at the time of death or disability. Typically, the employee or the employer (or both) make contributions to the employee's individual account under the plan, often at a fixed rate, such as 5 percent of yearly earnings. In most cases, these contributions are invested on the employee's behalf by the employer.

After a period of time, the employee will get the amount in their account, which is calculated on the basis of contributions plus or minus investments profits or losses. In response to changes in the value of the investments, the value of the account will fluctuate. Plan types that fall within the defined contribution category include 401(k) plans, 403(b) plans, employee stock ownership plans, and profit-sharing arrangements.

A Simplified Employee Pension Plan (SEP) is a retirement savings vehicle that is reasonably simple to understand. Contributions to individual retirement accounts (IRAs) owned by employees can be made on a tax-favored basis through a simplified employee pension (SEP). SEPs are subject to only the bare minimum in terms of reporting and disclosure obligations.

An employee who participates in a SEP is required to establish an IRA in order to accept contributions from the company. Employers are no longer permitted to establish Salary Reduction SEPs. Employers, on the other hand, are able to set up SIMPLE IRA programs that accept salary reduction contributions. Employers who used to provide a salary reduction SEP may continue to enable their employees to make salary reduction contributions to the plan.

In a profit sharing or stock bonus plan, the plan may specify, or the employer may choose, how much will be contributed to the plan on a yearly basis. Profit sharing plans and stock bonus plans are both types of defined contribution plans (out of profits or otherwise). The plan incorporates a formula for distributing a portion of each participant's yearly contribution according to the formula. A 401(k) plan may be included in a profit-sharing plan or stock bonus plan, among other things.

A 401(k) Plan is a type of defined contribution plan that can be used for either cash or deferred compensation. Employees have the option of deferring a portion of their income, which is instead donated on their behalf, before taxes, to a 401(k) plan, rather than getting the money out of their paycheck. These donations may be matched by the employer in some cases.

Each year, an employee's ability to postpone a certain amount of money is limited to a specific monetary amount. Employees must be informed of any restrictions that may be in place by their employer. Contributing part of their salary to a 401(k) plan and, in many cases, making investment decisions on their own behalf, employees who participate in 401(k) programs accept responsibility for their retirement income.

An Employee Stock Ownership Plan (ESOP) is a type of defined contribution plan in which the investments are predominantly made in the stock of the company in which the plan is offered to employees.

Cash Balance Plans are a type of defined benefit plan in which the benefit is defined in terms that are more similar to those of a defined contribution plan. With another way of saying it, a cash balance plan specifies the expected benefit in terms of a predetermined account amount or balances.

According to a standard cash balance plan, a participant's account is credited each year with both a "pay credit" (for example, 5 percent of the amount received from his or her job) and a "interest credit" (either a fixed rate or a variable rate that is linked to an index such as the one-year treasury bill rate). Increases and reductions in the value of the plan's investments have no direct impact on the benefit amounts that have been guaranteed to plan members and beneficiaries.

As a result, the employer is completely responsible for the investment risks and rewards associated with plan assets. Upon being eligible to receive benefits under a cash balance plan, the benefits that are received by the member are defined in terms of the amount of money that the participant has in his or her account balance.

The benefits of most cash balance plans, as well as the benefits of most classic defined benefit plans, are protected by government insurance provided via the Pension Benefit Guaranty Corporation, subject to certain restrictions and limits (PBGC).