Defined Benefit vs Defined Contribution

20 Dec 2011

Defined Benefit vs Defined Contribution Retirement plans have always been a popular topic in personal finance. People come up with different questions related to the difference between a defined contribution pension plan and a defined benefit pension plan. Regardless of their similar names, there are vast differences as to what they offer the employee at the time of retirement. Defined Benefit Pension A Defined Benefit pension plan, also known as the gold-plated plan is exactly as it sounds. A certain formula has been fixed to payout when it is time to collect. The formula incorporates a percentage of your average salary multiplied by the years of services you have provided over the years of your employment.

Government typically offers a Defined Benefit pension plan with 60 percent to 70 percent of the employees average salary over the several years of service once they reach thirty to thirty five years of service period. This means, if you are enrolled on a Government Defined Benefit pension plan for a long time, you will accumulate over thirty years of service at the age of early- to mid- fiftys. This will entitle you to claim a pension of around 66 percent of your salary. However, incase you reach the thirty five years of service milestone, you will receive around 70 percent of your salary during the retirement period.

Defined Benefit vs Defined Contribution There are many advantages of getting enrolled in such a pension plan because the retirement income incorporates the element of inflation and does not rely on market performance. Moreover, retirement income is high as compared to the size of contribution made by the employee. However, a major drawback of Defined Benefit pensions is its expensive nature due to which many employers have switched to a Defined Contribution Plan. Defined Contribution Pension

Defined Contribution Pension plan also possess a fixed nature but in terms of contribution. This plan has a predetermined contribution usually based as a percentage of the employees salary (with matching concept applicable). The benefit depends upon the performance of portfolio with no guarantees as to how much income you will generate during your retirement period. For a smart investor, a Defined Contribution Plan has the benefit of complete command over the portfolio/money. The investor can choose several assets and funds allocation within the pension plan.

The good side of Defined Contribution pension plan is that it lets you watch your portfolio/money grow. In short, what you see is what you get. You can plan over you investment strategies and your money management according to the flow that you are well aware of. However, the retirement plan completely depends upon the market performance over the period.
To conclude, it is not the decision of the employee to choose a pension plan for himself or herself. It depends entirely on the company, which pension plan they want to enroll you in. However, there are greater chances that you will be enrolled into Defined Contribution plan as it is becoming popular and is less risky for companies to manage.

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