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.

• 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)
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

Retirement plans have always been a popular topic in personal finance. People come up with different questions related to the difference between a defined contribution pension plan and a defined benefit pension plan. Regardless of their similar names, there are vast differences as to what they offer the employee at the time of retirement.

Defined Benefit Pension

A Defined Benefit pension plan, also known as the gold-plated plan is exactly as it sounds. A certain formula has been fixed to payout when it is time to collect. The formula incorporates a percentage of your average salary multiplied by the years of services you have provided over the years of your employment.

Government typically offers a Defined Benefit pension plan with 60 percent to 70 percent of the employee’s average salary over the several years of service once they reach thirty to thirty five years of service period. This means, if you are enrolled on a Government Defined Benefit pension plan for a long time, you will accumulate over thirty years of service at the age of early- to mid- fifty’s. This will entitle you to claim a pension of around 66 percent of your salary. However, incase you reach the thirty five years of service milestone, you will receive around 70 percent of your salary during the retirement period.

There are many advantages of getting enrolled in such a pension plan because the retirement income incorporates the element of inflation and does not rely on market performance. Moreover, retirement income is high as compared to the size of contribution made by the employee. However, a major drawback of Defined Benefit pensions is its expensive nature due to which many employers have switched to a Defined Contribution Plan.

Defined Contribution Pension

Defined Contribution Pension plan also possess a fixed nature but in terms of contribution. This plan has a predetermined contribution usually based as a percentage of the employee’s salary (with matching concept applicable). The benefit depends upon the performance of portfolio with no guarantees as to how much income you will generate during your retirement period.

For a smart investor, a Defined Contribution Plan has the benefit of complete command over the portfolio/money. The investor can choose several assets and funds allocation within the pension plan.

The good side of Defined Contribution pension plan is that it lets you watch your portfolio/money grow. In short, what you see is what you get. You can plan over you investment strategies and your money management according to the flow that you are well aware of. However, the retirement plan completely depends upon the market performance over the period.
To conclude, it is not the decision of the employee to choose a pension plan for himself or herself. It depends entirely on the company, which pension plan they want to enroll you in. However, there are greater chances that you will be enrolled into Defined Contribution plan as it is becoming popular and is less risky for companies to manage.

Defined Benefit Plan

This is a fixed form of payment made to employees once they are retired. This is why they are also referred to as “fixed benefit” or “final salary” funds. This payment is usually calculated by a formula that considers three of the following aspects:

• The amount of salary you are paid at the time of retirement. (This can be an average of the salary you are being paid for last two to three years of service)
• Considering the number of years you have served as a member in the fund
• The accrual required for calculation purposes

The formula goes like this – your average salary at retirement (multiplied by) years in service (multiplied by) 2.2%

Advantages

This plan has no uncertainty. The member has the exact information of the pension he is entitled to at the end of his service. Moreover, the member feels free to invest in different investment plans without fearing the risk of uncertainty at the time of retirement.

Disadvantages

Unlike defined contribution benefit, there is no guarantee whether your pension will incorporate the effect of inflation or not. If it doesn’t, you will face quite a loss on the retirement pension plan.

Moreover, to have a significant amount of pension set for you at the time of retirement, it is very important that you have a good average salary throughout your service years. If not, you can have a very low amount set for you.

Defined Contribution Funds

The nature of these contributions is also fixed in different terms and therefore is also referred to as “fixed contribution” or “money purchase” funds.  According to the funds specification, the contributions that the member is entitled to, do not guarantee the benefits of retirement.

However, there are certain aspects on which the benefits are dependent on. For example:

• The amount of contributions – contributed by the member and the employer
• The efficiency of the outcome of the investment plan
• Cost of administration
• The accumulation of withdrawal credits with the exemption of a member
• The consideration of annuity rates prevailing at the time of retirement

Advantages

Regardless of the uncertainty, there are chances that you receive higher pension than anticipated at the time of retirement. As a result of efficient investment performance, there is the likelihood that you receive a higher pension as compared to defined benefit pension.

Moreover, you can also expect to get the complete benefit if you change employment. You are also in a better position to make a choice between a range of investments. You do not have to worry about your average salary because the pension payment will not be determined on the basis of any formula.

Disadvantage

Uncertainty!! You can be left empty handed if your investment turns out to be a complete loss. This contribution plan is risky and requires proper know how before investment. In short, the pension depends entirely on investment and therefore members have no idea about the ultimate pension they will receive.