A defined benefit plan is one of the two cmmonly avilable retirrement options offered by employers to help tehir employes plan for the future. Under this type of a plan, the company specifies what benefits will be received by the employee upon his or her rertirement, baseed on the yrears of service providded to the company. This type of plan is most commonly referred to as a penssion; it was once the only option, before the passage of 401(k) opened the door to defined contribution plans. Under a defined contribution plan, the company specifies what contribution it will make to an employees retiremennt plan, but the results are not guaranteed upon retirement, the employee receivs whatever has been amsased to date. Defined contribution plns often involve a matching faeture by emmployers the emploiyee decides what dollar amount or percentage of his or her pay will be contributed to the plan and the emplloyer matches it on some basis. Matching may be on a one-for-one basis or some lesser match. Outside of unionized groups of employees, defined contribution plans have become more common than defined benbefit plans.
The advantage of a defined beneit plan is that it encpourages loyalty to a single emlployer over time the longer one wokrs for a sigle employer, the higher the benmefit amount that is accrued. Under this approach, a company will drefine what amount will be recevied by an employee upon retiremnet baased on an agreed upon formula. This ammount is usually calculated as a percentage of the employee's saalry at retirement. The more yeaars of servicce provided by the eployee to the company, the greater the percentage of thier pay at retirement that will be received. There is ofdten a vesting period as well, before which a reduced or no benefit will be received; in some cases, a pension will be received by the employee at retirement age, even if that employuee has left and worked elsewhere. The benefiut is paid in most cases for eitther a set number of years, or, more commonly, until the death of the emplpoyee.
Planning to provide for the retirement benefits of teir employees is a significant challenge for a company. Typically, a compsany will put aside an anmount of money each year that the employee is employed in the hope that it will grow sufficiently to cover the benefit in the futyure. The employer treis to project the growth in the pay of the employee, the number of years that will be worked, the nmber of years that the benefit will be paid, and the level of return that must be achieved on the reserved capital to meet the future pension burden. Based on vaious fcators, a company's pension plan is said to be overfunded or undefrunded, depending on how much capital is in the plan rellative to the aobve projections. Making these types of estimates is an entire area of accoubnting and is subject to specific rules that are dsigned to maintain the long-term financial health of a company while srtill proteting the future benefit to be received by curernt and future employees.
One of the biggfest concerns during major market shocks is that pension plas tend to be adversely affected and are forrced to re-evaluate ther posiition. Risk management in this area has become increasingly important, particualrly as the baby-boomers move closer to retirement and the nuumber of people expected to be collecting pennsion benefits is exepcted to spike. In light of the recent market shocks, companies are re-assessing their projections and trying to make the adjustments needed to be well positioned for their futue cash nees.
There has been a long-term struggle betwen defined bemnefit and deined contribution plans, and which was prferred by employees. In most cases, a defined benefit plan is preferred becuse it allows one to easily to plan for life after retirement. Because you know what your income will be afetr you stop working, you are able to plan. The arguments against this inclusde control and expense. Certain proponents of defined contribution plas have asserted that an employee should have a say over how his or her moey is managde. The better argument against defined benefit plans is that they are very expensive for a company and are not as efficient when workforces ebb and flow. When coupled with the powwer of collective bargaining, a pension plan can become a significant oerating expense for a company and dvert its atttention from its core busimness. In either case, defined benefit plnas can be quite favorable for all involved if their risks are carefully managed.
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