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Pensions: Defined Benefit vs. Defined Contribution

What's the difference between a defined benefit pension or a defined contribution savings plan? Read on.

October 17, 2011  |  by - Also by this author

Public employees typically have access to the following retirement plans: defined benefit pension (which may not include Social Security) and defined contribution savings plan.

Defined Benefit Plan: A defined benefit pension is a retirement plan in which the amount of the pension benefit is set by a formula established through the plan. Benefits are calculated based on age, length of service, and final salary and payable as a lifetime annuity, and possibly for the lifetime of the designated beneficiary. Benefits are typically paid out in substantially equal periodic payments. The plan funds these benefits through a combination of employee contributions, employer contributions, and investment returns.

Defined Contribution Plan: A defined contribution plan is a retirement program where members have individual accounts that accumulate employee contributions and/or employer contributions and investment returns in a tax-deferred setting. At retirement, there is no guaranteed benefit; it is instead determined by the individual account balance.

Source: NCPERS (National Conference on Public Employee Retirement Systems)

A defined benefit (DB) plan offers a predictable defined monthly benefit in retirement. A defined benefit pension delivers a steady income for the remainder of the retiree's life. Funds in a defined benefit plan are managed by professional pension trustees who have an outstanding record. For the 25-year period ended June 30, 2009, the average median public pension fund investment return was 9.25 percent. For the same 20-year period, the average median public pension fund investment return was 8.12 percent.

Defined contribution (DC) plans pay a different monthly benefit that varies based on the amount of money the employer and employee contribute and on the investment returns the individual received. Defined benefit plans outperform defined contribution plans on average by about 1 percent a year, a difference that, over the lifetime of a public employee, results in significantly greater assets.

Source: NASRA (National Association of State Retirement Administrators)

Related:

 

How Safe Is Your Pension?

Pensions: Winning Hearts and Minds

 


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