What is the defined benefit plans?
Defined benefit(1) | #Defined benefit | plans, as the name suggests, offer employees a specific benefit amount. This benefit amount may be based on a number of factors, but two of the most important are salary and years of service.
What is the defined contribution?
Defined contribution plans, on the other hand, work on the basis of a defined contribution made by the employee toward their retirement, with the employer offering a matching contribution up to a certain amount.
Investing with the degree of care
The difference in how these two types of plans are funded has profound implications for their administration. Because defined benefit plans guarantee certain amounts, the employer must ensure they invest carefully in order to be able to make good on their commitments.
Investing with the degree of care required for a defined benefit plan means an employer must undertake elaborate actuarial projections. They also need insurance, just in case their investment strategy fails to pay out.
All of that risk, and hedging against risk, is expensive. As a result, many employers have either cut back on them or done away with them altogether.
The employee and the employer agree on how to invest the money
Defined contribution plans, such as 401(k) and 403(b) plans, require employees to invest their own money in the plan. The amount invested may be a percentage of the employee’s salary, or it may be a specific dollar amount instead.
With a defined contribution plan, the employee and the employer sit down and agree how the money is to be invested. Most commonly, the investment is made in money market funds, mutual funds or annuities available within the plan.
The employee has the responsibility to direct all contributions invested in the plan
Because the defined contribution plan has the employee making the choice about how to invest, and because the employee is not guaranteed a fixed payout, there is far, far less risk for the employer. The employee has the responsibility to direct all contributions invested in the plan in order to ensure they have enough to retire on.
Defined benefit plans not to offer enough for a comfortable retirement
While defined benefit plans may sound preferable, the reality is that in most cases, these plans do not offer enough for a comfortable retirement.
It is true that defined-benefit plans offer certain security that defined contribution plans do not, since the employer has to guarantee that the money will be there, but a prudently invested defined contribution plan is likely to yield more. For this reason, employees who have the option of participating in both plans would do well to participate in the defined contribution as well as the defined benefit plan.
The two main kinds of retirement plans offer very different routes to security in retirement, and it is important to run the numbers and look carefully at the trade-offs when making one’s decision.
Defined benefit website | https://www.investopedia.com/ask/answers/032415/how-does-defined-benefit-pension-plan-differ-defined-contribution-plan.asp |