| |
  
Types of Retirement Plans
She tells me to start from the beginning, and pulls
out some paper and a pen to take notes. "I'll start off slowly," I
say, as she settles back into her swivel chair. "There are two categories
of retirement plans: defined benefit and defined contribution. In both
categories of plans, money is contributed to the plan, invested, and paid out to
the employee at retirement. The key difference between the two categories of
benefits lies in the allocation of risk and reward between the employees and the
employer." Risk and reward, topics an actuary can sink his teeth into.
"A defined benefit plan is a promise. The employer promises that the
employees will receive a specified benefit amount at retirement.
Contributions toward that benefit may come from just the employer, or
both the employees and the employer. In either case, the employer promises a
specific level of benefit, so the employer must ensure that sufficient funds are
available to pay for that benefit. The employer takes the risk that the funds
may fall short. If they do, the employer must make up the difference through
increased contributions."
"That's the downside risk," she pipes in,
"but what if things go well?"
"In that case, if the assets are more than
sufficient to pay for the benefits that were promised, the employer's
contribution is reduced."
"Makes sense," she responds, starting to
understand what she had gotten myself into. "The employer is taking the
risk, so the employer gets the reward."
"Exactly," I continue. "This is the
most common form of retirement plan used in the public sector. According to a
1994 study conducted by the Department of Labor, 91% of public sector employees
participate in defined benefit plans."
I had her attention. The facts were hitting her
like mosquitoes on a windshield. I went on. "A defined contribution plan is
a different kind of program. In a defined contribution plan, the contribution
into the program is specified. The contributions may come from either the
employer, the employee or both. In any case, the employees individually take the
risk that they will be able to accumulate sufficient assets to cover their
retirement needs. Likewise, the employees reap the rewards when enough money is
contributed and investment returns are good."
|
