Pension Plans Explained: Defined Contribution vs Defined Benefit Plans

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Pension Plans Explained: Defined Contribution vs Defined Benefit Plans

What are Pension Plans? 2:02
Key Differences between Defined Contribution and Defined Benefit Plans 5:05
Accounting for the 2 Types of Plans 10:05
Personal Finance Implications for Both Types of Plans 13:10

PERSONAL FINANCE & FINANCIAL PLANNING
Pension Plans:
Defined Contribution Plans vs Defined Benefit Plans

WHAT ARE PENSION PLANS?
Individual Investment Accounts to assist Funding Your Retirement

Individuals being encouraged to better fund their own retirement,
through individual investment accounts.

These can both reduce burden on state, while also improves the standard of living in retirement

These accounts funded by employers or individuals themselves and often receive favourable taxation treatment

These accounts have restrictions on accessing the funds prior to retirement

Pension Plans System often Dependant on National Jurisdictions

This video may be played anywhere in the world, so I have to talk in generalisations. But you’ll find specific systems, structures and rules are based on where you’re located.

In the US:
401(k) Accounts

In Australia:
Superannuation Account within a superannuation fund

In Ireland:
PRSA, or a Personal Retirement Savings Account

But no matter your location, the consensus view is that there are 2 Distinct Types, or categories, of Plans:
1) Defined Contribution Plan
2) Defined Benefit Plan

KEY DIFFERENCES BETWEEN 2 TYPES OF PLANS

Defined Contribution Plan:
* Employer only obligated to contribute set amount each period
* No guarantee of future benefits, only committed to the contribution.
E.g. minimum 9.5% of earnings in Australia
* Therefore the employee bears the investment risk

Defined Benefit Plan:
* Employer is obligated to provide an income stream post retirement
Income stream amount dependent on variety of factors, e.g. length of service or salary at retirement
* Employer bears investment risk
i.e. they the promising a particular income stream and must have the plan assets to meet these commitments
* In general:
These plans can cause huge liabilities for some companies
Are being phased out and 'defined contribution plans' are becoming the standard

ACCOUNTING FOR BOTH PLANS

Defined Contribution Plan:
* Much simpler accounting
* Income Statement:
‘Pension Expenses’ are just the contribution made
* Balance Sheet:
No impact, i.e. no recognition

Defined Benefit Plan:
* More complex accounting. Differences in accounting between IFRS and US GAAP
* Income Statement:
‘Pension Expenses’ can involve any new pensions earned by employees, benefits paid from past employees and interest
* Balance Sheet:
Compare the Plan Assets vs Estimated PV of Pension Obligations
Net pension asset or net pension liability on balance sheet

PERSONAL FINANCE IMPLICATIONS

Defined Contribution Plan:
* Must monitor Performance of Contributions
* Must monitor Allocation of Contributions
(1) Determine post retirement income needs,
(2) Estimate the balance needed that should generate that income,
(3) Plan to reach the balance needed by adjusting contributions
and monitoring fund performance

Defined Benefit Plan:
* Must monitor the financial strength of Plan
* Must monitor communications from the managing entity, and it’s management
* Learn the rules of how your Defined Benefit Plan works

DISCLAIMER
The business AccoFina, and myself the individual, are not giving personal advice in this video.
It is meant to provide factual information for educational purposes.
We do not know your personal circumstances and financial goals.
Neither AccoFina or myself hold an AFSL, nor are we authorised representatives of an AFSL holder. We are not a licensed financial advisor.
This is general information only and should not be taken as constituting professional advice. You should consider seeking independent legal, financial, taxation or other advice to check how this information relates to your unique circumstances,
before taking (or not taking) any actions.
AccoFina and myself are not liable for any loss caused, whether due to negligence or otherwise arising from the use of, or reliance on,
the information provided directly or indirectly, by this video.

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[marybethosazuwa]

I truly enjoyed watching the youtube video “Pension Plans Explained: Defined Contribution vs Defined Benefit Plans” it was filled with much information and insight throughout the entire video. I strongly believe that many individuals should watch this video and gain an understanding of pension. This is due to the fact that individuals need to be aware of their options before making a decision on the pension plan. I was able to learn about pension plans thoroughly, as the video explained as well as the difference between the two pension plans, there is define contribution and defined benefit plans. Both plans are effective, however, it is truly based on the type of job an individual may have, as well as the preference. Pension is started to help individuals begin saving for their retirement in the future, and in most cases, these accounts can be funded by either an individual or employers it truly depends on the circumstances. However, these accounts are put into place to help with retirement and have limitations and restrictions with trying to access the funds before the actual retirement. The difference between the two plans is that one the employer will contribute and meets the required obligation, whereas the other the employer must have a certain amount of the assets to meet the obligation to have a certain income in the retirement. This video was truly insightful and I am glad I was able to gain a better understanding.

[jakemoss]

This video was extremely informative and covered some of the key aspects with regards to pension plans that most employers tend to offer for employees. Specifically, in the video the topic of discussion within the realm of pension plans was the difference between defined contribution and defined benefit plans. Nowadays as evidenced in the tutorial employers are becoming more cautious of keeping costs lower and minimizing the amount of risk tied to employee plans. Thus resulting in a movement towards defined contribution plans from defined benefit plans. Defined contribution plans leave employers with a bill of a one time cost that isn't predicated on market volatility and can paint a clearer picture of their defined obligation to employees. Overall the structure of pension plans and this new trend and shift from one end of the spectrum to the other is predicated on industry trends and the economy with regards to the workforce.

[donaldtropp]

This video is an excellent resource about the two different types of pension plans (defined contribution and defined benefit) and the accounting and personal finance implications for both of these plans. It benefits anyone in the world who wishes to learn more about wealth building and retirement planning.

I think that this information should be taught as early as high school because I did not learn about pension plans until I was in college and my father retired after 30 years of working for the United States Postal Service (USPS). He has been drawing a defined benefit pension ever since, and my parents are living comfortably in South Florida.

I became more familiar with pension plans after graduating from college and entering the workforce. In a previous role as a human resources manager for a small private company, I selected, implemented, and managed a 401k employer-matching plan, which was a great experience. One of the many things I learned was that we should aim to save and invest as much as possible. As Albert Einstein said, "Compound interest is the eighth wonder of the world."

Several of my friends and relatives currently work for the federal government, which offers both plan options: the Federal Employees’ Retirement System (FERS) and a Thrift Savings Plan (similar to a 401k). Each plan option has its own pros and cons, but I think that being able to participate in both plans is most ideal.

Axel mentions pension plans can be very complicated so it is really important to educate and empower yourself and perhaps a good idea to use a financial planner or advisor to help map out your retirement plan. I liked how he ended the tutorial: “You’ll really have a better quality of life in retirement if you take control of your retirement pension plan.”

[estheresparza]

The video was very informative and did a good job of explaining the two types of pension plans most employees see today. I believe this type of information would be most beneficial if learned prior to entering the workforce for the first time. Unfortunately, pension plans seem to be a foreign concept for both persons entering the workforce for the first time and for some who have been in for a while. After watching this tutorial, I am better able to understand the differences between Defined Contribution and Defined Benefit plans. I now see why there seems to be a shift from Defined Benefit to Defined Contribution Plans (DCPs). In this day and age, there appears to be a greater push for employers to minimize costs and risks when it comes to employee benefits. DCPs are certainly more attractive to employers due to the one-time contribution cost and the simple accounting that comes with it. It seems as though Defined Benefit Plans (DBPs) will become a thing of the past with today’s culture of profit over people. DBPs belong to an era gone by where a company pledged to take care of their workers after years of loyalty and commitment.

[deniseburns]

Personal finance, financial planning is a necessary task, no one should work 30 years and have no retirement benefits available once they are older and no longer working. As an HR major and junior level human resource employee I know very little about employee benefits provided by the employer. For this reason, I thought the video did a great job explaining the differences between the two types of benefits: Defined Contribution and Defined Benefit plans. The defined contribution plan only obligates the employer to meet the plans percentage coverage and remaining balance to meet retirement fund qualifications is left up to the employee to fund. This gives the employee no guarantee of future benefits once the employer meets this obligation, therefore the employee bears the investment risk when using this type of plan because their employer does not guarantee full benefits upon retirement. On the other hand, the defined benefit plan guarantees the employer will provide an income stream post retirement up until the employee retires. I think people should consult a financial advisor to educate themselves on the best plan for their future retirement. I, myself like to go with what is guaranteed, so I would and have chosen the defined benefit plan.

[warholcow]

Thanks for the informative video. What are your thoughts on a DB traditional pension plan vs a hybrid (part DB and part DC)?

[johnyoest]

This video is required viewing by my graduate students in Compensation and Benefits at The Catholic University of America in Washington, DC

[chetnasharma]

Thank you for sharing your thoughts on pension plans focusing on the differences between defined contribution and defined benefit plans. It is clear why the defined benefit plans are losing their popularity among employers in the current market. It is interesting to note that employers are the drivers when it comes to deciding the benefit plans, which also suggests the current condition of the job market around us. While there is an ongoing debate over raising minimum hourly pay in the US to favor people with lower wages, it is also important to protect the future of the working-class by making sure that their future benefits do not entirely depend upon market volatility. I would advocate for a hybrid system that integrates the benefits of both defined contribution and defined benefit plans while mitigating the issues arising from it. I believe some organizations already have these hybrid plans, and it may be worthwhile to extend these plans to the more general public. Another dimension to these benefit plans is a social security benefit given by the government to almost all working people post-retirement. It would be interesting to see how these social security benefits compare against the defined benefit or defined contribution plan, its burden on government budgets, and how sustainable this benefit is for future generations.

[accofina]

First comment on the fresh Vid!

Cheers, and best of success,
Axel