What Is a Defined Contribution Pension Plan?
According to the U.S. Department of Labor, there are typically two types of pension plans: defined benefit and defined contribution. The former allows benefit payments to be calculated based on factors such as length of employment. Defined contribution plans are different because payments are calculated based on how much money you want to contribute.
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Significance
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Employers contribute a fixed amount of money to a defined contribution plan. For instance, you contribute money via payroll deduction to your plan and your employer may match that amount (in money or stock).
Types
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Examples of defined contribution plans are 401ks, Employee Stock Ownership Plans (ESOPs) and profit-sharing plans.
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Benefits
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Defined contribution plans grow faster in the early years of the plan, according to the Committee on Investment of Employee Benefit Assets (CIEBA). Also, this type of plan allows employees to take the benefits with them if they ever leave the company.
Warning
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Some risks to defined contribution plans are loss of assets, including poor investment fund selection, an unfavorable market or outliving your retirement funds. Thus, your retirement benefit under the plan is not guaranteed.
Payments
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You can request either a lump sum payment or regular periodic payments with defined contribution plans instead of monthly payments, which are typical for defined benefit plans, according to Prudential.
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