Basic Facts About Pension Plans: Defined Benefit Versus Defined Contribution By Lorabella At Isnare.com Ezine Articles

Pension plans are designed to provide an income for the individuals who have them once they retire. Several different types are currently available, depending on the individual’s place of employment. In general, contributions are made to a fund that will be held for the employee until he is ready to retire. It is this aspect that earns this type of plan the distinction of being called a type of deferred compensation for employees. The funds are then disbursed according to certain regulations or rules that have previously been set up once the employee retires.

The typical method of funding is for both the employer and the employee to make contributions into the retirement fund. In some cases, only the employer makes these contributions. However, this is becoming rarer in the workplace. Retirement plans are designed to provide monthly payments or increments that will last the individual throughout the remainder of his life.

Defined Benefit Pensions

Traditional pensions are often referred to as a defined benefit pension or DB plan. The specific figure of the retirement benefit in question is determined according to a particular formula that will take into consideration both the number of years that the employee will be working with the company as well as the final salary that the employee will be earning.

Traditional pensions cannot be outlived by the employee since they are designed to be payable for life. As such, they are pre-funded and designed to contain sufficient money to provide funds for the employee throughout his remaining years.

The funding status of a DB plan fluctuates throughout its existence. It is referred to as a percentage that portrays the relationship between the assets that are required to pay the benefits and the benefits themselves. For example, if a pension plan included a benefit promise of $15,000 and assets of $1500, then the funded status would be 10%. If the DB plan had $15,000 in both assets and the benefit promise, then the funded status would be 100% since they match in full.

Defined Contribution Pensions

With defined contribution pensions, or DC plans, the retirement benefit is determined by the employee’s contributions as well as the earnings on these contributions. Many employers will set up a system by which the employee can make contributions via salary deferral. In some cases, the employer will also contribute to the plan, adding to the employee’s contribution with a percentage of the amount he has placed into the fund.

Typically, the percentage that the employer will meet has a cap or restriction as to the maximum amount that he will meet any given contribution. Additionally, a certain cap exists on the percentage of his income that an employee can contribute to his retirement plan. Usually, the employee is able to change this percentage a certain number of times a year. However, some employers might allow a change only once a year on a predetermined date.

With a DC plan, the total amount of the retirement fund remains unknown until the employee retires from the company. The reason behind this is that the employee’s contributions do not have a rigid number that must be met each pay period. Plus, the earnings on the fund will vary depending on the strategy used for investment purposes.
Each employee typically has some control over the manner in which his retirement fund is invested. Positive returns on the fund will be credited to the individual’s account. Likewise, any losses or negative returns will be subtracted from the individual’s DC account as well.

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