Do you know how defined benefit plans differ from defined contribution plans? A defined benefit plan when you retire, guarantees you a certain benefit. A defined contribution plan when you retire, depends on the amount of contributions made and the investment performance of the assets. Often your defined benefit plan is not enough. so it is good to participate in more than one plan.
Defined benefit plans offer tax incentives to the employers and to the participating employees. Tax incentives come with strings attached, by having a complex set of rules under the ERISA and the Internal Revenue Code.
The amount you will receive from this pension will depend on factors from your salary, age, and your years of service with the company you worked for. Employers, generally are the ones who contribute to this plan. Some companies require that you work for them for a certain amount of years before you have rights to any retirement benefit. In other words, you have to be fully vested to participate in getting retirement benefits from the plan.
Defined contribution plans do not depend on the employee’s years of service or earnings history. Employees have control over this plan by how their contributions are invested and they generally can choose from stocks, bonds, and mutual funds. Examples of defined contribution plans are 401k plans, 403b plans, and 457 plans. A defined contribution account can contain a specific balance at any time.
It is easy to confuse a defined benefit plan and a defined contribution plan. Just remember that, the defined benefit plan focuses on the benefits that are paid out, and the defined contribution plan focuses on current contributions made to the plan.
Your employer promises to pay you a certain amount at retirement in the defined benefit plan, and they have to make sure those funds are available to pay out the amount owed, even if the investments don’t perform well.
However, in contrast, your employer is not obligated to pay you a specific amount at retirement in the defined contribution plan. You will actually receive a certain amount, depending on the investments you have chosen and how your investments performed.
Knowing how these plans differ, you should be able to see that defined contribution plans are riskier for employees. Employees are bearing the risk of assets that are not performing well. You should know how much to expect from your defined benefit plans, when you are ready to retire. Remember that there is usually no cost of living adjustments in defined benefit plans either.
Both of these retirement plans are great plans. Having a retirement plan is beneficial so that you can retire with ease. Stay at your job until you are vested so that you have a good retirement plan in place. Knowing the difference in defined benefit plans and defined contribution plans can be very beneficial. Choose wisely with the plans you participate in. Be prepared for your future.