Defined Benefit Plans
Defined benefit plans offer a fixed benefit for the employee upon retiring that was pre-established. The program provided fixed annuities payable on a monthly basis and based on a formula that accounts for the years of service, the compensation that can be earned and a benefits multiplier not on the account balance upon retiring. In most cases, employees value the benefits offered by the plan. They are more complex and difficult to compute than other programs. The employer can contribute and deduct more. A business of any size can use a defined benefit plan. The benefits cannot retroactively be reduced. The holder can also have other retirement plans. An actuary determines the level of funding and signs schedule B. The holder must also file form 5500 and schedule B every year.
A defined benefit plan accrues or provides substantial benefits within a short time. It also allows the employers to contribute or deduct more than other programs. It offers predictable benefits which are not dependent on asset return. It is the most costly and administratively complex type of plan. The minimum contribution requirements must be met or else exercise tax will apply. Similarly, the tax will apply if excess contributions are made to the program.
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The employers make most of the contribution to the pan but the employee at times can make voluntary contributions. The benefits accrued from the plan are limited where the deducted amount is limited to the current unfunded liabilities. The program may also permit participants loans. It is difficult for the plan to make in-service distributions to participants before they reach the age of 62.
Defined benefits are aimed at providing the holder lifetime retirement income where members and employers contribute a percentage of the salary. The contributions are invested in a pension fund which is later used to pay the members' lifetime pensions. Professionals manage the investments based on professional guidelines that are established to protect the members. The earnings determine the income from the pension and the service whereby the more the service, the higher the pension. A member receives the pension for his or her life once they start earning it. Additional benefits of a defined benefits plan include; early retirement benefits, inflation protection, survivor benefits and disability benefits.
Defined Contribution plans
Defined contribution plans like 403(b), 457 or the Thrift Saving do not promise a fixed benefit at retirement. The programs offer an account in which the employer and employee contribute. The holder of the plan selects an investment from available options and the retirement benefits are based on the account balance. The employer allocates contributions to the employee’s account. The benefits payable from the plan depends on the value of account balance upon retirement.
Define contribution plans are intended to help a person accumulate retirement savings when they are still working. The employer and employee contribute a certain percentage of the individual's salary, and the money is deposited in an individual account set up in their names. The owner decides how the cash is invested mainly from several investment options. The money in the account can be used to buy annuities or even transferred to a monthly income stream.
The length and size of the income depend on the contribution, interest rates, and the investment return. There are no certainties that the revenues will last for one's entire life. Some of the ancillary benefits of the plan include inflation protection which tends to make it expensive for the member thus reducing the available amounts for an income stream.
One example of a defined contribution plan is the state optional retirement program which is administered to all employees of state agencies, public and charter school districts, and institutions of public higher education. The program is also available to people first elected to the South Carolina General Assembly in or after 2012. For one to be eligible, they must be employed by a participating employer and be eligible for membership in SCRS
Calculations for two plans
Defined benefits plans can be calculated using three formulas; Final average earnings, average career earnings and flat benefit. The final average earnings use average earnings in the years to retirement. If the benefit percentage is 2% while the average salary is $50,000 for 20 years, the annual pension will be $50,000 X 2% X 20 = $20,000.
Defined contribution formulas include money purchase plans where an amount is contributed to the account that grows with interest. Target plans involve the contribution of amounts based on targeted benefits. Social security integration consists of the excess only that integrates on the wage base with a maximum difference of 7.5%.
Selecting the best option
The best choice to choose from is a defined benefit plan because it has the advantage of offering the security of regular income as opposed to savings. The employer also shoulders the risk of investing as the individual carries all the investment risk. Highly investment professionals are responsible for making investment decisions. The member can also estimate in advance the value of their pension as benefits are predefined and therefore members are aware of what they will receive. In a defined benefits plan, additional benefits are built in and do not have to worry about any other costs of an annuity. The program is favorable to older longer-serving employees.
A defined contribution specifies how much the employer will contribute to the plan and the employee is responsible for the investment risk. It offers portable benefits while favoring younger workforce. It is also easier to communicate and administer as there are fewer government regulations.
