Defined Contribution vs. Defined Benefit: A $5 Trillion Difference

Defined Contribution vs. Defined Benefit: Which Retirement Plan is Right for You?

When it comes to retirement planning, there are two main types of plans to consider: defined contribution plans and defined benefit plans. Both types of plans have their own advantages and disadvantages, so it's important to understand the differences between them before making a decision.

Defined Contribution Plans

With a defined contribution plan, your employer makes regular contributions to your retirement account. The amount of the contribution is fixed, and it is not based on your salary or years of service. You are responsible for managing the investments in your account, and you bear the risk of loss.

There are two main types of defined contribution plans: 401(k) plans and 403(b) plans. 401(k) plans are offered by private-sector employers, while 403(b) plans are offered by public-sector employers.

Advantages of Defined Contribution Plans

• You have control over your investments. You can choose how your money is invested, and you can make changes to your investment strategy at any time.
• You are not responsible for funding the plan. Your employer is responsible for making the contributions to your account.
• You may be able to take advantage of tax benefits. Contributions to defined contribution plans are typically tax-deductible, and earnings grow tax-deferred.

Disadvantages of Defined Contribution Plans

• You bear the risk of loss. If the investments in your account lose value, you will lose money.
• You may not have enough money to retire. The amount of money you have in your account at retirement will depend on the performance of your investments and the amount of time you have to save.
• You may have to pay fees. Some defined contribution plans charge fees for investment management and other services.

Defined Benefit Plans

With a defined benefit plan, your employer promises to pay you a specific monthly benefit at retirement. The amount of the benefit is based on your salary and years of service. Your employer is responsible for managing the investments in the plan, and you do not bear the risk of loss.

There are two main types of defined benefit plans: traditional pension plans and cash balance plans. Traditional pension plans are the most common type of defined benefit plan. Cash balance plans are a newer type of defined benefit plan that is becoming increasingly popular.

Advantages of Defined Benefit Plans

• You are guaranteed a specific monthly benefit at retirement. You do not have to worry about the performance of the investments in the plan.
• Your employer is responsible for funding the plan. You do not have to contribute to the plan.
• You may be able to take advantage of tax benefits. Contributions to defined benefit plans are typically tax-deductible, and earnings grow tax-deferred.

Disadvantages of Defined Benefit Plans

• You do not have control over your investments. Your employer is responsible for managing the investments in the plan.
• Your benefits may be reduced if the plan is underfunded. If the plan does not have enough assets to cover its liabilities, your benefits may be reduced.
• You may have to pay fees. Some defined benefit plans charge fees for investment management and other services.

Which Type of Plan is Right for You?

The best type of retirement plan for you will depend on your individual circumstances. If you are comfortable with risk and want more control over your investments, a defined contribution plan may be a good option for you. If you prefer a more secure retirement and do not want to bear the risk of loss, a defined benefit plan may be a better choice.

Here are some questions to ask yourself when making a decision:

• What is your risk tolerance?
• How much control do you want over your investments?
• How much money do you want to save for retirement?
• What are your retirement goals?

Once you have answered these questions, you can start to compare the different types of retirement plans and choose the one that is right for you.

Key Differences Between Defined Contribution and Defined Benefit Plans

The following table summarizes the key differences between defined contribution plans and defined benefit plans:

Trends in Defined Contribution and Defined Benefit Plans

The popularity of defined contribution plans has been increasing in recent years, while the popularity of defined benefit plans has been declining. This is due to a number of factors, including:

• The rising cost of providing defined benefit plans.
• The increased risk of defined benefit plans being underfunded.
• The desire of employees for more control over their retirement savings.

According to a recent study by the Employee Benefit Research Institute, 61% of private-sector employers offered a defined contribution plan in 2020, compared to just 23% that offered a defined benefit plan.

The Future of Defined Contribution and Defined Benefit Plans

The future of defined contribution and defined benefit plans is uncertain. It is likely that defined contribution plans will continue to grow in popularity, while defined benefit plans will continue to decline. However, there is still a role for defined benefit plans in the retirement system. Defined benefit plans can provide a secure retirement for employees who are willing to accept the risk of the plan being underfunded.

Conclusion

Defined contribution plans and defined benefit plans are two different types of retirement plans with their own advantages and disadvantages. The best type of plan for you will depend on your individual circumstances. If you are comfortable with risk and want more control over your investments, a defined contribution plan may be a good option for you. If you prefer a more secure retirement and do not want to bear the risk of loss, a defined benefit plan may be a better choice.