Defined benefits and defined contributions are not the same thing, and consumers should educate themselves on the differences to ensure their retirement investment opportunities are not squandered.
In defined benefits plans, sometimes called DB plans, "employers provide employees a specific retirement benefit based on salary and years of service." the financial services firm TIAA-CREF noted
DB plans may be funded solely by contributions from an employer. Or, in some cases, they may also require an employee to contribute, TIAA-CREF said.
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DB plans are rather risk-proof for employees as the funds are managed by professional firms and also pooled. Best of all, said TIAA-CREF, DB plans offer a lifetime income stream, allowing someone to have the security of knowing a financial plan for retirement is in place. Typically, benefits are calculated based on career earnings at the end of their work life.
In contrast, a defined contribution plan, referred to as a DC plan, functions like a team effort between employer and employee. Both contribute funds to an employee's retirement account. The amount contributed is typically a percentage of the employee's salary, noted TIAA-CREF.
"A DC plan with a fixed annuity option … can also supply guaranteed lifetime income. Adding a variable annuity option allows the participant to invest in equities, bonds, real estate and other types of asset classes potentially to earn additional income," TIAA-CREF said.
DC plans offer portability. That alone is a strong benefit as more employees change jobs and move in search of better work, TIAA-CREF said.
Rules for contributions to both DB and DC plans are covered by the U.S. Department of Labor under the Employee Retirement Income Security Act (ERISA) of 1975. ERISA "sets minimum standards for most voluntarily established pension and health plans in private industry to provide protection for individuals in these plans."
Rules for the plans are outlined on the federal agency's website
Some finance services experts describe a DB plan as a better deal for employees, because they do not shell out money from their wages for benefits. That falls to an employer. With a DC plan — like a 401(k) or 402(b) plan — employees must make contributions.
In recent years, however, many companies have cut back on extending DB plans to new employees, CNN said
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"While it's nice to know exactly what you will receive as your payout, some defined benefit plans do not adjust your future payouts to keep pace with inflation," CNN added.
DB plans tell a retiree what their payout will be, "regardless of the returns on the pension fund's investments," noted Investopedia
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