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Difference Between Defined Benefit and Defined Contribution

Defined Benefit vs Defined Contribution

Because retirement has become a very big concern in today’s tough times, many are asking as to what type of pension plan is better for them. Is it the defined benefit plan or is the defined contribution pension plan better? Well, both have their own sets of pros and cons.

The DBP (Defined Benefit Pension) is a gold-plated plan that has a fixed computation. It tallies your total years of work times a given per cent of your average pay over your last few years of work. Most government mandated benefit plans give 60%-70% of the worker’s average pay over his last few years of work once they achieve the 30-35 years’ service level.

The pros of a DBP include inflation adjustments and market performance independency. The retirement pension is usually huge (about 70%) of the worker’s contribution. In addition, the highest level of monthly income is usually reached immediately before the retirement stage which works in favor of the worker in bolstering the overall computation of his pension. This is also the reason why tenured workers like the DBP.

On the downside, DBPs only allocate a small portion of the pension to the worker’s spouse in case of his death. Other pension plans are more flexible with regard to this aspect. DBPs are also seen by many employers as a costly option for retirement and pension that’s why they now prefer the DCP alternative instead.

In this connection, DCP (Defined Contribution Pension) is based on a fixed percentage from the worker’s salary (matched by his employer). DCP is dependent on portfolio performance so there’s really no assurance as to how much you’ll get upon your retirement. DCP is a good choice for some because you can see your money grow in the process, and in the end what you see is just about what you’ll get. You will also have more control over your portfolio or money within this type of plan. By contrast, if the performance of your portfolio isn’t looking very good, the chance is that your retirement income will also become somewhat affected. The employee might also need to contribute extra effort in being involved in his portfolio so as to generate better results.

In reality, the worker doesn’t have much say as to what type of plan to choose because it is his employer that is working it out for him being one of their tenured employees.

Summary:

1.DBP can be adjusted for inflation.
2.DBP is usually huge and tends to be more costly for most employers.
3.DCP allows the worker to have some control over his own portfolio.
4.DCP can end up being small if the worker’s portfolio didn’t turn out as expected.


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