Pension Basics
One of our main jobs is helping our clients untangle the different sources of income to project what we can expect at retirement. This often involves reviewing various pension statements, which can be vaguely communicated. Below is a summary of both types of pensions with supporting articles for further information.
Defined Benefit Pension:
A defined benefit pension plan is a type of pension plan where the retirement benefit is predetermined based on a formula that takes into account factors such as an employee's age, salary, and years of service. These plans are usually offered by employers and provide employees with a guaranteed income in retirement. The responsibility for managing the investments and assuming the investment risk lies with the employer or the pension fund. The benefit received is typically a fixed monthly amount for the rest of the retiree's life.
Summary
Traditional pension plan.
Based on years of service and top earning years.
Employer is responsible for any investment decisions.
DB is most common among government employees.
Defined Contribution Pension:
A defined contribution pension plan is a type of pension plan where the contributions made by the employee and/or employer are invested in individual accounts. The ultimate benefit received at retirement is based on the performance of the investments made. These plans are becoming more common and are often offered as an alternative to defined benefit plans. The responsibility for managing the investments and assuming the investment risk lies with the employee. The benefit received depends on the contributions made, the investment returns, and the annuity purchased at retirement.
Summary
The most common modern style of plan.
Employee decides investment decisions.
More flexibility in income timing, and account structure after leaving employer.
Larger variations in retirement income plan.