Key Takeaways
- Defined benefit plans and defined contribution plans are both retirement plans.
- These plans have some key differences, though.
- Defined contribution plans have been in existence since 1980.
“Cut and dried.” “Make hay while the sun shines.” “Spill the beans.” These old sayings have become so ingrained in our daily lexicon, that we often forget their origins. They came to be through particular meanings and they have a history to them.
Similarly, the retirement planning arena has a history, and it didn’t always look the way it does today. You’ve likely heard of a defined contribution plan, because that’s a 401(k) plan. However, you may not have heard of a defined benefit plan, as there are very few of them these days.
So, what’s a defined benefit plan? It’s a benefit that’s funded by your employer (not by you) – it’s a pension. The benefit is defined at a retirement age, based on a set formula. For example, at age 65, you’d receive 50% of your final salary each year.
People who work for the government, a municipality, or a school district, generally have a defined benefit plan. The employer is putting money away for the employees each year, and when the employees retire, they receive their pensions.
On the other hand, defined contribution is where you define and make the contribution (your employer may as well). This is your 401(k) plan, and the history of it is that it has been in existence for a little more than 40 years. Prior to that (the late 1970s), there were only defined benefit plans.
Then in 1978, Congress passed an act that became effective on January 1st, 1980, allowing employees to put their own money away for retirement. Why? Well, pension plans were becoming more and more expensive for companies and many of them stated they could no longer afford them.
These days, fewer than 10% of companies provide pensions, and this transition of more and more companies moving away from pensions and towards 401(k)s looks like it’ll continue. So the responsibility shifted to the employee, which is why you now put money away in your 401(k) plan and define your own contribution for your retirement. Until next time, enjoy.
