The retirement plan is a simple concept. In brief, regular payments are made during an employee’s working years into a fund, which will be used to cover regular payments made out to the same person during their retirement years. However, retirement plans can be categorized into either defined benefit plans or defined contribution plans based on their specific terms.
Like their name suggests, defined benefit plans promise set incomes to be paid out during their recipients’ retirement years. In contrast, defined contribution plans promise set contributions to funds held under their recipients’ names. As a result, people with defined contribution plans take on a small amount of risk in exchange for increased control over their retirement, which is one of the reasons that there have been more than a million members of these retirement plans since 2013.
How Does a Defined Contribution Plan Help Employees with Retirement?
Since defined contribution plans need a lot less management than defined benefit plans, it is clear why more and more employers prefer the first to the second. However, it is important to note that defined contribution plans have a number of important benefits for employees as well:
- Generally speaking, people with defined contribution plans have a lot more control over their saving for retirement than people with defined benefit plans. After all, they can put their contributions in an investment of their choice, meaning that they can control how much risk that they are willing to take on in exchange for how big a rate of return. In some cases, they can even control the size of their savings because their employers have promised to match their contributions, which allows for even finer control.
- Defined contribution plans are much more portable than their counterparts, meaning that their members can just take their savings with them when they change their place of employment. In contrast, if people with defined benefits plans want to do something similar, they will almost certainly face serious penalties.
- Curiously, a case can be made that a defined contribution plan is actually less risky than a defined benefit plan because of potential bankruptcies. In short, a defined benefit plan will stop paying out if the employer becomes insolvent, meaning that the retired employee will be faced with unexpected hardships. Although this scenario can seem improbable, the case of Nortel proves that it can happen.