If we are in our 20s and 30s then a Defined Contribution Pension Plan may be a better option for us than a Defined Benefit Pension Plan.
As we graduate from college and enter the workforce we will need to choose our employee benefits which may include health and medical coverage, life insurance, and our pension plan options. As employees, we usually have 2 options to choose from when deciding on a Retirement Savings Plan.
A Defined Contribution Pension Plan is an option that allows us to contribute a fixed percentage of our annual salary through payroll deductions. With a Defined Contribution Pension Plan the employee retains total control over the investment options as well as the contribution amount. Our employee contributions are defined by a fixed percentage rate and are usually matched by our Employer.
The contributions are known with a Defined Contribution Pension Plan, but the amount at retirement is unknown. Employees contribute a fixed contribution amount, and we choose and manage our investment options over the years. We have the option to invest in stock, mutual funds, or low risk term deposits.
The total amount, including both Employee and Employer contributions, belongs to the employee; we are able to take it with us if we leave our employer. This is a major reason why I feel the Defined Contribution is a better option for our Retirement Savings Plan if we are in our 20s and 30s. I once read that the average young professional under 30 changes jobs every 5 years. As we grow our careers and move from employer to employer, our money will move with us.
A Defined Benefit Pension Plan is the exact opposite of a Defined Contribution Pension Plan. With a Defined Benefit Pension Plan the primary contributions come from the Employer and Employee contributions are optional. Our Employer contributes to our pension plan on our behalf and therefore the Employer retains total control over the investment options, as well as the management of the account.
We often do not know the exact formula of employer contributions into our defined benefit Pension Plan and we also do not know the exact investments, although they are usually very low risk term deposits, bonds, or preferred shares in the company. This information is unknown, but it is also not relevant. The monetary benefit at retirement is guaranteed and therefore everything up to our retirement date is irrelevant.
The formula for a full Defined Benefit Pension Plan benefit is usually a magic number that consists of our age at retirement, plus our number of years of service with one employer. As a Financial Planner who specializes in investment and retirement planning, I often see the magic number as 85. This means that in order for an employee to obtain full benefits (i.e. $3000 per month) their age plus the number of years of service must equal 85. As an example if James is 55 and he has been working for the same employer for 30 years, he is eligible to retire with a full Pension benefit.
The Defined Benefit Pension Plan is not an admirable option for young professionals because we are unlikely to finish our careers with the same employer as we started them with. I, for one, enjoy having control of my own retirement accounts and choosing my own investment options.
(Photo By Michelena )