Defined benefit retirement plans offer a lifetime income stream in retirement, but the plans also have drawbacks.
These plans, also referred to as DB plans, may not give an employee enough income to live on in retirement, according to CNN Money
, which recommended that employees participate in both defined benefit and defined contribution plans, if possible, offering them variety and more opportunity for a greater payout.
Under defined benefit plans, "employers provide employees a specific retirement benefit based on salary and years of service," according to the financial services firm, TIAA-CREF
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While some DB plans can be funded solely by contributions from an employer, employees may also be required to contribute as well.
DB plans offer a lifetime income stream with little risk as the funds are managed by professional firms and also pooled. Typically, benefits are calculated based on career earnings at the end of their work life.
But among the drawbacks of a DB plan, employees have little control over how funds get invested, CNN said. They also don't allow employees to invest more into a plan if the choose, forcing them to contribute to a 401(k) plan, for example, or an IRA, if they want to earn more.
"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
. "The company is on the hook for whatever the fund can't generate, it said, adding for that reason, DB plan popularity is waning as companies have begun restricting participation to those who had previously been enrolled.
One downside of the DB plan weighs heavily upon small business owners, The New York Times noted.
Since they created the plan, they have to finance it at the level of benefit they set, and fill in the gaps, should the plan's value falter in the marketplace.
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"The primary problem with defined-benefit plans is you have to fund at least to a minimum level each year,” Abilene, Texas CPA Jerry Love told the Times. “You also have to have an actuary do your actuarial analysis each year. And you have to fund the minimum amount, or your plan’s in violation and you have all kinds of problems.”
He added: "The No. 1 thing that happens to people is their company or industry takes a dip and they don’t have the cash flow to fund the plan,” Love said. “There is no option. You have to fund this.”
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