Defined Benefit vs Defined Contribution Two Categories of Employer-Sponsored Retirement Plans
Have you come across different retirement plans or heard the terms Defined Benefit plan and Defined Contribution plan? The meaning of these terms may not be yet clear to you, but these are important terms for you to understand as these are the two types of plans that are used, if you are trying to find out the most suitable retirement plan for your business earnings and your retirement goals.
A traditional defined pension plan offers a preset amount to employees that they receive once they reach retirement. This amount is determined considering the length of service and the salary that an employee has been working for. The employee continues to receive the predetermined amount (plus increase in the cost of living) for the years to come.
Defined Benefit vs Defined Contribution Defined Benefits vs. Defined Contribution Two Categories of Employer-Sponsored Retirement Plans Have you come across different retirement plans or heard the terms Defined Benefit ...
Defined Benefit vs Defined Contribution This particular pension plan is known as defined benefit, as it is based on the annual or quarterly contribution on factual determination related to the employers benefits. The formula incorporates time value of money to ensure the correct amount is contributed in current terms to fulfill the requirement of retirement payments required in the future. These protuberances use a rational anticipated return rate.
In spite of the uncertainty in investment returns, it is sometimes possible to obtain the benefits of retirement. The highest amount that can be contributed each year is less than:
One hundred and eighty thousand dollars OR
Compensation based on average calculation of your 3 highest consecutive years
On the other hand, Defined Contribution plan is where the employees contribute a part of their salary into a retirement account where it can be invested in bonds, stock, mutual funds, shares, etc. Up to a certain percentage, some companies prefer to make a matching contribution. The account is filled up through investment earnings and contributions until retirement. In a Defined Contribution plan, you are uncertain about the amount of money you will receive at the time of your retirement. In fact, poor investment choices may leave you empty handed in the end.
Private sector does not follow Defined Benefit plans anymore. Companies that still run this traditional pension plan, offer them to only long-time employees whereas new employees are registered into a Defined Contribution plan.
So what is the logic behind switching from Defined Benefit to Defined Contribution?
To sum up the answer in one word sustainability!
Because Defined Benefit is a promised benefit that obligates a company to devote more resources to pay as workers retire and begin to claim their benefits. With such a smart switching decision, companies no longer have to worry about the colossal payments they had to make to fund the pension plan.