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Basic
Types of Retirement Plans
"I've
done a little studying since last time," she volunteered in her distinctive
high soprano, "and I think we can finish this up in about an hour. It's
pretty clear that defined contribution plans are better than defined benefit
plans. They're becoming a lot more popular in the private sector. We just need
to explain why and show how they will work at our agency."
We'd
been down this road together before. She knew that she could get me excited
by discussing retirement plans. I grabbed a black pen, made sure that it went
with the dry erase board, and wrote "Defined Benefit (DB) versus Defined
Contribution (DC)" at the top. I then wrote headings for two columns at the
far right labeled "DB" and "DC". The smell of the pens got
my mind back to our deadline. I had to limit the parameters for our discussion.
"Since we don't have much time, let's stick to traditional defined benefit
and defined contribution plans. A traditional defined benefit plan pays a
monthly amount determined on the basis of the employee's service with the agency
and pay level at retirement."
"I
remember from our last discussion," she said coolly. "Contributions
are made by both the employee and the employer. The employer guarantees there
will be enough money to pay for the benefit. If it costs more than we expect,
the employer has to pay more. If it costs less, the employer gets a break."
She
knew her DB plans. I tried the DC side. "A traditional defined contribution
plan allocates a percentage of each employee's pay to an account each year. The
employee often gets to decide how the account is invested." Without missing
a beat, she chimed in, "The employee is making the decisions, so the
employee takes the risks. If the investments do well, the employee has a nice
retirement. If the investments don't do as well, the employee is forced to work
for a few more years. Either way, the employer's contribution is fixed."
She
had been studying. "Did any of these articles explain why defined
contribution plans were becoming so popular?", I said as I sat down.
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