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Home > Definitions & Designations > The Defined-Benefit Plan

The Defined-Benefit Plan

Money Manager | Monday, October 25th, 2010

Defined-benefit plans have a long history, dating back to when retirement benefits were promised to those who served in the Revolutionary War. As the number of industries and companies increased, so did the popularity of these plans. Defined-benefit plans tend to provide the security of greater retirement benefits, especially for those who live many years past their retirement date. These plans guarantee a certain level of benefits to be paid to the employee on a continuing basis for the rest of their life after retirement. As a result, keeping these plans properly funded can sometimes be daunting for companies that offer them, especially as the overall life expectancy continues to increase.

How do defined-benefit plans work?

Defined-benefit plans place all the responsibility for making investment decisions in the hands of the employer. The employer also bears all of the financial risks for any investments that are made to fund the plan. There has been a steady shift away from defined-benefit plans over the last couple of decades, in favor of plans that place more of the financial responsibility for retirement funds on the employees themselves. Although many people prefer the option of playing a part in managing their retirement funds, it has been quite a mental shift for some people. There have been ongoing concerns that leaving retirement planning in the hands of the general population might result in large numbers of people reaching retirement age without adequate financial resources. Some people feel that defined-benefit plans are a better option for most employees. As a whole, corporations have welcomed the shift away from defined-benefit plans, since the overall costs of providing defined-contribution plans is usually much less.

What are the advantages of defined-benefit plans?

On the average, the benefits provided by a defined-benefit plan often tend to exceed the benefits of a defined-contribution plan. These plans also give employees the peace of mind of knowing that they will have a dependable income that they can count on for as long as they live after they retire. For those who hold a private sector job, contributions to these plans are usually the responsibility of the employer, although it is common for public sector employees to also make contributions to the plan.

Are there any disadvantages to defined-benefit plans?

Some feel that when a company operates a defined-benefit plan, the expenses of administration are too high to justify the benefits. Companies who have these plans often need to spend a lot of time and resources just administering the retirement plan, as compared to the much simpler administration required by a defined-contribution plan. These plans also tend to be much less portable than defined-contribution plans, and can create somewhat of an age bias, since it can cost much less to fund a pension plan for a younger employee as compared to an older employee. Employees also do not have any control over the funds in these plans. Unfortunately, many companies experience deficits in funding with these plans, when the total amount required by pension obligations exceeds the amount of money in the plan.

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