Defined Benefit Retirement Pension
The defined benefit retirement pension is one of the most popular means to save money for use in your post retirement years. In this type of pension plan, your employer will contribute a certain amount of money that is fixed keeping in mind your monthly income and also annual salary in an account which can be accessed to withdraw money every month after retirement. In the defined benefit retirement system an employer follows a certain fixed or defined formula for calculating the amount of money that will be deposited in the employee’s account. The formula for calculating this type of pension is based on certain basic components like the tenure of an employee in an organization, his age during retirement and the history of his total earnings from the organization. Other investment options are not taken into consideration while calculating the defined benefit retirement pension. The guidelines followed by private and public sector companies in the case of this type of pension plan are different from one another. In the case of a privately owned company, the total savings is based on the contribution made by the employer and not the employee. In public sector companies, both the employer and the employees contribute in the defined pension fund. Again, in several small private firms, where the entire business interests of the company rest on the shoulders of a single person, the contributions are shared by both the employer and the employees. There are several pros and cons of the defined benefit retirement plan which inspire people to choose or ignore this investment alternative.
Why will you choose defined benefit retirement plan?
A report by the Pension Benefit Guaranty Corporation says that more than 35,000 defined benefit pension plans exist in the financial market today. This number is starkly low in comparison to more than a lakh of such pension systems which operated less than fifteen years ago. The review says that the decline in the number must be blamed on the unsuccessful performance of the defined benefit contribution in providing a good post retirement investment opportunity. It is true that this type of pension plan is complex and also incurs a higher cost by the employer. However it also several benefits which wins the defined benefit pension plan some support. Let us underline some of the advantages of this type of retirement investment plan:
- Contribution to this type of pension plan means that several financial benefits can be availed by employees even if he chooses to retire earlier than the date and age set by the employee or his organization.
- Vesting in the pension account can be done immediately or can also be done over a period of seven years.
- The benefits from the defined pension fund do not depend upon the asset returns.
- If you have chosen to get yourself a defined benefit retirement pension, it will never collide with other pension plans that you may have chosen to be a part of.
- Owners of businesses of any size, large or small, can opt for the defined benefit pension plan to provide for the pension accounts of their workers.
- The benefits which are accrued from the defined benefit pension account can never be retroactively decreased.
- A retiree can reap huge benefits from this type of pension in a very short period of time.
- An employer can either contribute or remove more from the defined benefit retirement pension account than he does from other retirement accounts of employees.
- This type of retirement investment plan is often used to promote small and medium sized businesses. Early retirement advantages provided by this type of account are in reality a strategy to promote business interests.
Disadvantages of Defined Benefit Retirement Pension Plan
This type of retirement plan may be extremely beneficial to the employees, but it also has its downsides. There are some disadvantages attached with the defined benefit pension plan which make this plan unpopular with certain employers. Some of these disadvantages are:
- If you have to avail the benefits from this type of plan, you will have to fill up Schedule B of Form 5500 at regular intervals every year. Only an enrolled actuary has the right to fill this form.
- The defined benefit pension plan is considered the most costly retirement investment plan existing in the financial market today.
- It is not only more expensive, this type of pension plan also has its share of administrative complexities.
- A minimum amount to be contributed by the employer towards this pension account is fixed by the government. On failure to contribute this minimum sum of money, the employer will have to pay a certain percentage of excise tax.
Types of Defined Benefit Retirement Pension
There are two basic types of defined benefit retirement plans used by employers to contribute to the pension accounts of employees. They are:
- Unfunded Defined Benefit Pension – This is the more common type of defined benefit funding that is used by employers all over the world. The unfunded system requires no assets to be kept aside by the employer. The benefits of the pension account are paid by the sponsor or by the employer, as may be the case. In most countries this benefit is paid from current taxes or social security contributions.
- Funded Defined Benefit Pension – In this type of pension plan, some amounts of contribution is made by employers and sometimes also by plan members towards the fund of benefits. The return from these investments and hence the future benefit is known to nobody before the benefits are actually accrued and therefore the amount of contributions to be made is also unknown. Most employers have to review the amount of contributions made periodically so that the plan remains in accordance to the assets and liabilities of the company.