The book discusses Defined Benefit and Defined Contribution Pension plans (401k

Question

The book discusses Defined Benefit and Defined Contribution Pension plans (401k & 403b) and says that there are more Defined Contribution plans than Defined Benefit plans, but that there are more participants in Defined Benefit plans. This is a relatively recent (over the last 20 years) phenomenon. Companies have been moving away from Defined Benefit plans in favor of Defined Contribution plans. Why has this shift been taking place? Why do you think that there are more participants in Defined Benefit plans?

Explanation / Answer

Defined Benefit and Defined Contribution Pension plans (401k & 403b)

There are several kinds of retirement plans that employers can provide as a benefit to employees. We can put most plans into one of two major categories: (1) Defined Benefit plans or (2) Defined Contribution plans. Generally companies that begin a retirement plan for a benefits package today will opt for a Defined Contribution plan because Defined Contribution plans places employees in the driver seat towards control all investment risk and investment portfolio options than the employer.

Defined Benefit plans : Calculate employee benefits using a formula. The formula often will include factors like salary history and duration of employment. Employers control all investment risk and investment portfolio options.

Defined Contribution plans: Contain a number of investment options – mutual funds, stocks and other investment options can be available within the plans. Employees generally choose whether to contribute and how much to contribute through salary deduction. In some cases employers also contribute money to an employee’s individual plan. In every case, employees choose how to invest their own money, within the parameters of the plan options.

Even after so-many preference to Defined Contribution plans, there are more participants in Defind Benefit plans as Public schools, colleges, universities, charities, state governments, local governments and other tax-exempt entities are having a separate primary retirement plan, often a Defined Benefit pension plan which has an additional vehicle for retirement savings.

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