Defined Benefit vs. Defined Contribution
There was a time when employers offered one kind of retirement plan: a pension plan. You worked for many years for the same employer, and you got a monthly check when you reached retirement age. These days, though, other kinds of retirement plans are being offered as alternatives to traditional ("defined benefit") pension plans. These other retirement plans don't use a formula to determine your retirement benefit. They are often described as "defined contribution plans." So what's the difference between the two?
Here's how to tell a defined benefit plan from a defined contribution plan:
|Defined Benefit Plans||Defined Contribution Plans|
|How it's funded||Contributions depend on how much is necessary to fund the benefits paid to all participants, and are put in a pool (determined by an actuary)||Contributions are typically based on a percentage of pay and are put in your account|
|Who invests, takes on risks and rewards||Employers||Employees|
|Your benefit â€” the amount you receive||Based on a formula using your service, age and pay.||Depends on contribution amounts and the performance of investment funds you choose (including fees charged to you by those funds)|
It may seem that your comfort with making investment decisions is the biggest factor when you have a choice between a defined benefit and defined contribution retirement plan. However, it's not the only factor -- in many cases, the amount of time you spend with your employer makes an even bigger difference. In any event, no matter which plan you choose, personal savings is practically a necessity to ensure that you have enough income in your retirement years to lead the lifestyle you want.