Defined Benefit Plans vs. Defined Contribution Plans: What You Need to Know
Saving for retirement is a common goal for many. One means of achieving this is for employees to take advantage of different types of retirement benefits offered by their employers to save money for their future retirement. Different retirement plans provide different options for how you can save, how much you can save, and what benefits you can expect from your employer. It is important to have an understanding of your benefits that allows you to protect yourself in the case that you are denied your benefits.
The Employment Retirement Income Security Act of 1974, or ERISA, is the federal statute that protects employees’ benefits. You can find out all you need to know about ERISA on our frequently asked questions page and on our ERISA and Insurance Litigation Blog. If you believe you are not getting your benefits, reach out to us to find out how we can utilize ERISA to help you recover the benefits you are owed.
Additionally, find out more about the difference between defined benefit plans and defined contribution plans below.
What Is a Defined Benefit Plan?
A defined benefit plan is a retirement plan that promises to pay a specific benefit each month once you reach a certain age. The plan defines the age of eligibility, commonly between 62 and 65. Some defined benefit plans promise a specific dollar amount as a benefit, like $200 per month once you reach retirement age and retire. Others promise a benefit that is calculated based on your salary and years of service with your employer.
For example, determining the benefit might involve calculating your average salary over the last few years and multiplying it by a percentage determined by your years of service with your employer(s).
Positive Aspects of Defined Benefit Plans
Employers often contribute more to defined benefit plans than to defined contribution plans every year, which can benefit you in the form of tax savings. A defined benefit plan may also allow you to accrue more benefits in less time than with other plans, depending on the plan structure. A defined benefit plan also allows you to rely on the security of predictable payments in retirement.
Example of a Defined Benefit Plan
Imagine that Bob works for a company that offers a defined benefit plan. Bob’s employer contributes a certain amount to the plan. The plan, or a contracted third party, will then invest the contributions. Bob does not have any say in those investments or how they are handled, but his employer guarantees that Bob will receive a certain pension benefit upon retirement, which may be $100 per month in pension funds for every year he works for his employer. If Bob worked 10 years with the employer, his employer would guarantee him a pension of $1,000 per month.
What Is a Defined Contribution Plan?
A defined contribution plan is a savings vehicle that helps employees save for retirement, but it does not provide a specific promised benefit amount. The employee contributes to the plan, typically with pre-tax dollars. The employer may match the employee’s contribution up to a certain amount.
Contributions are invested to accrue additional value over time. Once you reach retirement age, you can begin to withdraw from the retirement plan as needed and according to IRS tax requirements. Examples of defined contribution plans include 401(k) and 403(b) plans.
Positive Aspects of a Defined Contribution Plan
While employee and employer contributions are capped at lower annual rates annually in a defined contribution plan, contributions are discretionary, allowing for greater flexibility in employers offering, and employees participating in, such plans. Defined contribution plans tend to be more common in the private sector today and are more favored by many employers, partly because they are less complex and less expensive to manage than defined benefit plans.
Hypothetical Example of a Defined Contribution Plan
Use Bob as an example again, but now he has a defined contribution plan rather than a defined benefit plan. Bob decides to contribute 4% of his salary to the plan and the employer matches up to 3%. The money contributed goes into a retirement fund specifically for Bob, and he is able to see and make changes to how the money is invested. Bob can decide whether he wants to play it safe or be a bit more aggressive with his retirement investments.
When he retires, Bob does not receive a specific amount every month based on his tenure and average salary. Rather, he can simply withdraw the amounts he needs, in accordance with IRS rules, from his retirement fund.
Does ERISA Cover Both Defined Benefit and Defined Contribution Plans?
Both a defined benefit and a defined contribution plan are covered by ERISA, so long as the plan is offered as an employer-sponsored benefit by a business in the private sector.
What If You Are Being Denied the Benefits You Are Owed?
Based on the above information, the importance of understanding the nature of your retirement benefits is clear. If you do not understand how your benefits work, you do not know whether you are getting what you are owed.
If you believe you are not getting the benefits you are owed, your best course of action is to reach out to someone with expertise in handling ERISA pension/retirement matters, like the experienced ERISA attorneys at McKennon Law Group PC. The knowledgeable ERISA pension attorneys at McKennon Law Group PC have helped their clients recover benefits owed to them and can help ensure that you receive the pension benefits you are due under your pension plan. Contact McKennon Law Group PC today for more information.