WHAT IS THE DIFFERENCE BETWEEN A “DEFINED BENEFIT PLAN” AND A “DEFINED CONTRIBUTION PLAN”?
With a defined benefit plan, the amount of the participant’s benefit is based on a formula that typically takes into account the participant’s years of service, age, and compensation. Based on these factors the participant will receive a “defined monthly benefit at retirement. Distribution of benefits cannot begin until the participant attains early retirement age as defined by the plan (e.g., age 55 with 10 years of service). Additionally, distribution typically is made in the form of a monthly annuity for the life of the participant or of the joint lives of the participant and surviving spouse. Also, benefits under a DBP are federally insured by the PBGC in the event the plan is under funded. Some examples of common names for defined benefit plans include “ABC, Inc. Retirement Plan”; “ABC, Inc. Employee Retirement Plan”; or “ABC, Inc. Employee Pension Plan”. Plan names can sometimes be misleading and you should check the plan’s provisions to determine the exact type of plan you are d
A defined benefit pension plan promises to pay a specific benefit at retirement. The employee does not bear any investment risk; if the plan does not have enough assets to pay the “defined” benefit, the employer must fund the plan so that the full benefit can be obtained. Defined benefit plans are generally insured by the Pension Benefit Guaranty Corporation (PBGC). A defined contribution plan is an individual account plan in which the employee makes a pre-determined contribution that grows tax free until withdrawal. An employer may make contributions to the employee’s account, but is not required to make sure that the account reaches a specific balance. Thus, the employee bears all of the investment risk. Defined contribution plans are not insured by the PBGC.
