Confused? Defined benefit and contribution pension plans explained

Differences along with advantages and disadvantages of both

A defined contribution plan provides an individual account for each participant. The benefits are based on the amount contributed and are also affected by income, expenses, gains and loses. Some examples of defined contribution plans include 401(K) plans, 403(b) plans, employee stock ownership plans and profit sharing plans.

A defined benefit plan promises the participant a specific monthly benefit at retirement and may state this as an exact dollar amount. Monthly benefits could also be calculated through a formula that considers a participants salary and service. A participant is generally not required to make contributions in a private sector fund but most public sector funds require employee contributions. Unlike defined contribution plans, the participant is not required to make investment decisions.

Advantages of Defined Benefit Plans

• Guaranteed retirement income security for workers
• No investment risk to participants
• Cost of living adjustments ["COLA" to us]
  
• Not dependant on the participant’s ability to save
• Tax deferred retirement savings medium

Disadvantages of Defined Benefit Plans

• Difficult to understand by participant
• Not beneficial to employees who leave before retirement

Advantages of Defined Contribution Plans

• Tax deferred retirement savings medium
• Participants have a certain degree of how much they choose to save
• Can be funded through payroll deductions
• Lump sum distributions may be eligible for special 10 year averaging
• Participants can benefit from good investment results
• Easily understood by participants

Disadvantages of Defined Contribution Plans

• Difficult to build a fund for those who enter late in life
• Participants bear investment risk

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