Question

9-5. Are employees more likely to favor defined contribution plans over defined benefit plans? How about employers? Explain your answers.

Answer 1

Are employees more likely to favor defined contribution plans over defined benefit plans? How about employers? Explain your answers.

            A defined benefit plan identifies the specific benefit that will be payable to you at retirement. Your basic retirement benefit is usually based on a formula that takes into account factors like the number of years a participant works for the employer (years of service) and the participant's salary. Your retirement benefit is generally provided in the form of regular payments over your lifetime beginning at what the plan calls "normal retirement age," which is typically age 65. This stream of periodic payments is generally known as a pension or sometimes called an annuity. A defined contribution plan specifies how much money will go into a retirement plan today. The amount typically is either a percentage of an employee's salary or a specific dollar amount. Then, those funds often are invested in mutual funds available inside the retirement plan. The amount you have at retirement depends on how much your employer contributes to the plan, how much you as the employee save in the plan, how long you leave those funds invested, and how well your investments perform inside the plan.

            In a defined benefit plan the employee’s pension benefit entitlement is determined by a formula which takes into account years of service for the employer and, in most cases, wages or salary. Many defined benefit formulas also take into account the Social Security benefits to which an employee is entitled. Both plans have significantly different characteristics with respect to the risks faced by employers and employees, the sensitivity of benefits to inflation, the flexibility of funding, and the importance of governmental supervision. Because defined benefit plans are more costly for employers than defined contribution plans, most of them have scaled back dramatically or eliminated these plans altogether in recent years.

References:

Martocchio, Joseph. Strategic Compensation: A Human Resource. Publisher: Pearson-Prentice Hall Edition: 8^th, 2013