A defined benefit plan, also known as the traditional pension, was once offered by many employers but is increasingly rare today in the private sector. It pays a retiree a specific benefit based on years of service and salary level until they die. In some cases, the payouts will continue for a spouse or other beneficiary.
Monies are usually contributed both by the employer and the employees, although in some cases an employer might pick up the entire contribution. Funds are pooled and investments managed professionally, sometimes in-house if the fund is large enough.
Many DB plans include some kind of cost of living adjustment. Some, like the Wisconsin Retirement System, allow participants to receive a larger benefit when investments perform well but make smaller payouts when the markets are down.
Defined contribution plans are generally known by the Internal Revenue Service tax codes that permit them, such as 401(k) or 403(b). They allow workers to make pre-tax contributions to their own retirement accounts. In some cases, employers will chip in a percentage or match contributions made by employees.
The onus is on the employees to manage their own investments. Most DC plans offer participants a choice of mutual funds or other investment vehicles through a third party that holds the account. The IRS allows withdrawals without penalty beginning at age 59½.
Of course, the biggest difference between a defined benefit and a defined contribution plan is that a traditional pension provides a stream of income until death while the money in a 401(k) is gone when the savings run out. A 401(k) is essentially just a savings account with tax advantages.
Studies also show that defined benefits plans tend to outperform defined contribution plans because of the lower fee structure and professional investment management.
In addition, many individuals who manage their own retirement assets tend to do worse than the professionals. That’s because people tend to buy stocks when the prices are high and panic when markets fall and sell low.
Because defined benefit plans are more costly for employers than defined contribution plans, most private-sector employers have scaled back dramatically or eliminated these plans altogether in recent years. If you still have a defined benefit plan at your company, count yourself fortunate.
In 1983 more than 60 percent of American workers had some kind of defined benefit plan. Today, it’s less than 20 percent. Most Americans largely rely on Social Security as their de facto retirement plan.
But having a defined benefit pension doesn’t guarantee you’ll get all the money you’ve been promised. If a company or employer declares bankruptcy, the court can alter the pension plan and leave workers collecting pennies on the dollar.
Source: The Cap Times
Too bad and your Social Security is draining our economy! You’d better start investing in our reckless, volatile markets and don’t ask for an increase in the minium wage if you want to return to school before the better jobs are outsourced. Just remember don’t ask for any educational funding either.
Sorry states, your cash cow for helping us not to raise taxes or being fiscally responsible has died. Suckers! And thank you Tea Party voters for your continued support. We’ll take care of you, trust us…