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lancelotarnold

Defined Benefit vs. Defined Contribution Plans

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The main difference between defined benefit (DB) plans and defined contribution (DC) plans are where the money comes from.

In a defined benefit plan, the employer contributes the money to the pension, which the employee receives on retiring. DBs are based on a fixed sum and are guaranteed to pay out to employees, regardless of how the business is performing financially. This is because the Pension Benefit Guarantee Corporation — a federal agency created following the Employee Retirement Income Security Act — helps protect pension funds.

Companies often have difficulty maintaining DB plans because they carry the financial burden. If inflation occurs, the stock market drops or the company revenue is declining, they may have to pay for the pension with out-of-pocket funds.

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In 2014, DC assets increased by 12.8 percent, compared to DB assets that increased 6.4 percent, according to the nonprofit Pensions and Investments.

As a result, many employers are now choosing DC plans because they do not require as much of a financial investment from the company. In these plans, such as IRAs and 401(k)s, the employee is responsible for adding money to the account. In some cases, employers may offer a small matching program to incentivize employees to save for retirement. IRA and 401(k) plans are advantageous because they allow employees to earn tax-deferred growth on their savings.

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