Defined Benefit vs Defined Contribution – Two Categories of Employer-Sponsored Retirement Plans
Have you come across different retirement plans or heard the terms Defined Benefit plan and Defined Contribution plan? The meaning of these terms may not be yet clear to you, but these are important terms for you to understand as these are the two types of plans that are used, if you are trying to find out the most suitable retirement plan for your business earnings and your retirement goals.
A traditional defined pension plan offers a preset amount to employees that they receive once they reach retirement. This amount is determined considering the length of service and the salary that an employee has been working for. The employee continues to receive the predetermined amount (plus increase in the cost of living) for the years to come.
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Defined Benefit vs Defined Contribution
Defined Benefits vs. Defined Contribution – Two Categories of Employer-Sponsored Retirement Plans Have you come across different retirement plans or heard the terms Defined Benefit …
Defined Benefit vs Defined Contribution This particular pension plan is known as defined benefit, as it is based on the annual or quarterly contribution on factual determination related to the employers’ benefits. The formula incorporates time value of money to ensure the correct amount is contributed in current terms to fulfill the requirement of retirement payments required in the future. These protuberances use a rational anticipated return rate.
In spite of the uncertainty in investment returns, it is sometimes possible to obtain the benefits of retirement. The highest amount that can be contributed each year is less than:
- One hundred and eighty thousand dollars OR
- Compensation based on average calculation of your 3 highest consecutive years
On the other hand, Defined Contribution plan is where the employees contribute a part of their salary into a retirement account where it can be invested in bonds, stock, mutual funds, shares, etc. Up to a certain percentage, some companies prefer to make a matching contribution. The account is filled up through investment earnings and contributions until retirement. In a Defined Contribution plan, you are uncertain about the amount of money you will receive at the time of your retirement. In fact, poor investment choices may leave you empty handed in the end.
Private sector does not follow Defined Benefit plans anymore. Companies that still run this traditional pension plan, offer them to only long-time employees whereas new employees are registered into a Defined Contribution plan.
So what is the logic behind switching from Defined Benefit to Defined Contribution?
To sum up the answer in one word – sustainability!
Because Defined Benefit is a promised benefit that obligates a company to devote more resources to pay as workers retire and begin to claim their benefits. With such a smart switching decision, companies no longer have to worry about the colossal payments they had to make to fund the pension plan.
| DEFINED BENEFIT PLAN Kentucky Teachers’ Retirement System (KTRS) | DEFINED CONTRIBUTION PLAN Optional Retirement Plan (ORP) |
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| Vendors | KTRS | Members can elect from four retirement vendors: • Fidelity • ING • TIAA-CREF • VALIC |
| Service Retirement | Eligible at any age with 27 years of service; age 60 with 5 years of service. Reduced benefit retirement if fifty-five (55) or more but less than age sixty (60) who have ten (10) or more years of service, but less than twenty-seven (27) years of service. Upon retirement, participants are eligible to draw a retirement allowance for life regardless of how much is contributed to the retirement system over one’s career. The formula at full retirement is as follows: Final Compensation x Benefit Factor x Years of Service Credit = Annual Benefit Contributions to KTRS are currently fixed at: • 7.16% from the employee • 14.84% from the employer | Eligible to withdraw funds at age 59 1/2. Income at retirement is based on the value of the member’s account. Contributions to the ORP are currently fixed at: • 6.16% from the employee • 8.74% from the employer |
| Vesting | Employee is vested after 5 years of service | Employee is immediately vested |
| Investment Allocation Decisions | Made by KTRS financial and investment professionals | Each employee makes all investment allocation decisions for his/her account |
| Investment Risk and Reward | Employee assumes no investment risk | Investment risk is assumed entirely by the employee. All gains or losses accrue to the member’s account. |
| Inflation Protection/COLA | Annual 1.5% cost-of-living adjustments after retirement | Automatic cost-of-living adjustments are not provided |
| Benefit Portability | Upon separation from employment, members are eligible to withdraw their contributions. Employer contributions are not eligible for withdrawal. Account withdrawals are paid as lump-sum distributions, part of which may be taxable at the time of withdrawal, or may be rolled over to an IRA, an eligible employer plan or another qualified plan. Member is no longer eligible for KTRS service retirement once account is withdrawn. | Upon separation from employment, members are eligible to withdraw the full value of their account. Both employee and employer contributions and the gains or losses on those contributions are eligible for withdrawal. Account withdrawals are paid as lump-sum distributions, part of which may be taxable at the time of withdrawal, or may be rolled over to an IRA, an eligible employer plan or another qualified plan. |
| Disability Benefits | After 5 years of service, members are eligible to apply for disability benefits under the disability allowance program. | Account balance is available to members who terminate employment and withdraw their account. |
| Death and Survivor Benefits | Qualified survivors are eligible to receive benefits. A $2,000 life insurance benefit is also provided. Visit www.ktrs.ky.gov for specific details regarding death and survivor benefits | Account balance available to beneficiaries. A spouse may continue to manage the member’s account or withdraw the account. |
| Health Care Coverage | Upon attaining retirement status, individuals (including disability benefit recipients and survivor benefit recipients) and their dependents are eligible for access to optional health care coverage with KTRS. | Healthcare coverage is NOT available to retirees. |
| Traditional Method of Payment at Retirement | A lifetime annuity. Several different payment plans to protect survivors are available. | Members can take payment through a rollover, a lump-sum withdrawal or a variety of lifetime annuities. |
Thank you : WKU MANDATORY RETIREMENT PLAN COMPARISON CHART Defined Benefit vs. Defined Contribution Plan
