Characteristics Of Defined Benefit And Defined Contribution Plans

Defined Benefit Plan

Defined Contribution Plan

Employer Contributions and/or Matching Contributions

Employer funded. Federal rules set amounts that employers must contribute to plans in an effort to ensure that plans have enough money to pay benefits when due. There are penalties for failing to meet these requirements.

There is no requirement that the employer contribute, except in the SIMPLE 401(k) and Safe Harbor 401(k)s, money purchase plans, SIMPLE IRA and SEP plans.
The employer may choose to match a portion of the employee’s contributions or to contribute without employee contributions. In some plans, employer contributions may be in the form of employer stock.

Employee Contributions

Generally, employees do not contribute to these plans.

Many plans require the employee to contribute in order for an account to be established.

Managing the Investment

Plan officials manage the investment and the employer is responsible for ensuring that the amount it has put in the plan plus investment earnings will be enough to pay the promised benefit.

The employee often is responsible for managing the investment of his or her account, choosing from investment options offered by the plan. In some plans, plan officials are responsible for investing all the plan’s assets.

Amount of Benefits Paid Upon Retirement

A promised benefit is based on a formula in the plan, often using a combination of the employee’s age, years worked for the employer, and/or salary.

The benefit depends on contributions made by the employee and/or the employer, performance of the account’s investments, and fees charged to the account.

Type of Retirement Benefit Payments

Traditionally, these plans pay the retiree monthly annuity payments that continue for life. Plans may offer other payment options.

The retiree may transfer the account balance into an individual retirement account (IRA) from which the retiree withdraws money, or may receive it as a lump sum payment. Some plans also offer monthly payments through an annuity.

Guarantee of Benefits

The Federal government, through the Pension Benefit Guaranty Corporation (PBGC), guarantees some amount of benefits.

No Federal guarantee of benefits.

Leaving the Company Before Retirement Age

If an employee leaves after vesting in a benefit but before the plan’s retirement age, the benefit generally stays with the plan until the employee files a claim for it at retirement. Some defined benefit plans offer early retirement options.

The employee may transfer the account balance to an individual retirement account (IRA) or, in some cases, another employer plan, where it can continue to grow based on investment earnings. The employee also may take the balance out of the plan, but will owe taxes and possibly penalties, thus reducing retirement income. Plans may cash out small accounts.