Certified Plan Sponsor Professional (CPSP) Practice Exam

Which of the following characteristics is typical of a defined contribution plan compared to a defined benefit plan?

1. The plan offers fixed retirement benefits

2. The plan has predictable funding requirements

3. The employee bears the investment risk

4. The employer contributes a set amount annually

The correct answer is: The employee bears the investment risk

The characteristic that is typical of a defined contribution plan compared to a defined benefit plan is that the employee bears the investment risk. In a defined contribution plan, such as a 401(k), the contributions made to the plan are typically invested in various options chosen by the employee, and the retirement benefits depend on the performance of those investments over time. As a result, the employee assumes the risk associated with market fluctuations and investment choices, which can lead to varying retirement outcomes. In contrast, a defined benefit plan guarantees a specific benefit amount at retirement, often based on factors like salary and years of service. The employer is responsible for managing the investments and assumes the investment risk in a defined benefit structure. This key difference highlights how defined contribution plans shift the investment risk from the employer to the employee. The other characteristics listed in the question, such as fixed retirement benefits, predictable funding requirements, and set annual contributions by the employer, are not indicative of a defined contribution plan. These are more aligned with the characteristics of defined benefit plans, reinforcing the distinction between the two types of retirement plans.