Defined Benefit vs. Defined Contribution: 4 Key Differences

Defined benefit (DB) and defined contribution (DC) pension plans are two of the most common types of retirement plans offered by employers. Both types of plans offer tax-advantaged savings, but there are some key differences between them that you should be aware of before making a decision about which type of plan is right for you.

Defined Benefit Plans

Defined benefit plans are traditional pension plans that promise to pay you a fixed monthly benefit for life once you retire. The amount of your benefit is based on a formula that takes into account your years of service, your salary, and your age at retirement. For most people, retiring from a defined benefit plan is the surest way to guarantee a predictable level of income in retirement.

How Defined Benefit Plans Work

With a defined benefit plan, your employer is responsible for managing the investments and paying out the benefits. This means that you don't have to worry about making investment decisions or managing your account balance. You can simply focus on saving for retirement and planning for the future.

Benefits of Defined Benefit Plans

• Guaranteed income for life
• No investment risk
• Potential for higher benefits than with a defined contribution plan

Drawbacks of Defined Benefit Plans

• Less flexibility than with a defined contribution plan
• Employer contributions may be reduced or eliminated in the future
• Benefits may be taxed as ordinary income

Defined Contribution Plans

Defined contribution plans are retirement plans that allow you to contribute a portion of your paycheck to an investment account. The money in your account grows tax-deferred, and you can withdraw it tax-free in retirement. The amount of money you receive in retirement will depend on how much you contribute to your account and how well your investments perform.

How Defined Contribution Plans Work

With a defined contribution plan, you are responsible for managing your own investments. This means that you need to make investment decisions and monitor your account balance. However, you also have more flexibility with a defined contribution plan. You can choose to invest your money in a variety of different assets, and you can change your investment strategy at any time.

Benefits of Defined Contribution Plans

• More flexibility than with a defined benefit plan
• Potential for higher returns than with a defined benefit plan
• Tax-deferred growth

Drawbacks of Defined Contribution Plans

• No guaranteed income for life
• Investment risk
• Benefits may be taxed as ordinary income

Which Type of Plan Is Right for You?

The best type of retirement plan for you depends on your individual circumstances and financial goals. If you are looking for a guaranteed income for life and you are not comfortable with investment risk, then a defined benefit plan may be a good option for you. However, if you want more flexibility and the potential for higher returns, then a defined contribution plan may be a better choice.

4 Key Differences Between Defined Benefit and Defined Contribution Plans

Tips and Tricks for Choosing the Right Retirement Plan

• Consider your age, salary, and retirement goals.
• Talk to a financial advisor to get personalized advice.
• Compare the different types of retirement plans offered by your employer.
• Make sure you understand the terms and conditions of your plan.
• Contribute as much as you can afford to your plan.
• Review your investment strategy regularly and make changes as needed.

Common Mistakes to Avoid

• Not saving enough for retirement.
• Investing too conservatively.
• Not taking advantage of employer matching contributions.
• Withdrawing money from your retirement account before you retire.
• Rolling over your retirement account to a new employer without understanding the tax consequences.

Conclusion

Defined benefit and defined contribution plans are both valuable tools for saving for retirement. However, there are some key differences between the two types of plans that you should be aware of before making a decision about which type of plan is right for you. By understanding the benefits and drawbacks of each type of plan, you can make an informed decision about how to save for

Sources:

• Employee Benefit Research Institute
• Internal Revenue Service
• National Association of Retirement Plan Participants