Defined Benefit Plan

• Definition & Nature:

It is a pension plan that relates to payment of specific benefits on a monthly basis. This is based
on a formula that includes the employee’s age at the time of retirement, rate of pay, and length of
service.
The employer is responsible for investing the contributions to ensure there’s enough money to pay
the future pensions for all plan members. If there’s a shortfall in the money needed, the employer
must pay the difference.
➢ Generally, all employees participate in these plans.
➢ The employer is responsible for keeping the fund sufficiently funded and for paying the
monthly benefits promised by the plan.
➢ The employer bears both Longevity Risks and Investment Risk.
➢ It provides survivor benefits for the spouses of retirees. This means that, when the retiree
dies, the retiree’s spouse receives a certain percentage of the monthly benefit the retiree
had been receiving for the rest of the widow or widower’s life.
➢ A defined benefit pension is generally not assignable to third parties.

Defined Contribution Plan

• Definition & Nature:
It is a plan that is based on a defined amount which is contributed either by an employer or
employee. In some cases, both the employer and employee tend to contribute.
Employees are responsible for investing all contributions to grow their savings whereas the
employer matches some of the contributions made by the employees.
➢ Employees may choose to participate or not in this retirement savings plan.
➢ Eventual payout depends on the amount contributed and the investment performance of the
account.
➢ The “longevity risk” is completely on the employee.
➢ An employee may elect any surviving beneficiary to receive the remaining value of
the account upon his or her death.
➢ Higher level of portability is available with defined contribution plans. The employee may
have the option to take a loan or hardship withdrawal while employed, and will be able to
withdraw or roll over the account into some other plan or investment vehicle when he
leaves employment with the plan sponsor.
 Differences Between Defined Benefit Plan & Defined Contribution Plan
Summary Table
ATTRIBUTES Defined Benefit Defined Contribution
i). Participation • All employees • Choice of employee
ii). Formula for Benefits • Uses formula • No formula is used
iii). Funding Responsibility • Employer • Employee or Employer
• Both
iv). Survivor’s Protection • Yes • No
v). Cost of Living Adjustments • Very Possible • impossible
vi). Portability • No • Yes
vii). Risk Bearer • Employer • Employee