Defined Retirement Plans – Defined Retirement Plan
Most people in today’s work world do not know there are two typed of defined retirement plans. They are only aware of the 401(k) retirement plan. This plan is the prevalent type of retirement plan today so it is no wonder folks are not aware of the other type of retirement plan.
The 401(k) is a defined contribution plan. The other type of defined retirement plans is called a defined benefit plan. Generally speaking these are your traditional retirement plans. Some people call them a pension and, in fact, it was the prevalent plan until a few years ago.
There is a difference, as you might expect, between these two plans. The defined-benefit plan is exactly that, a defined benefit. It will typically pay you a set amount each month in retirement.
Notice please that being one of the defined retirement plans it does its retirement magic in the form of a set payout when you retire. How much you will receive when you retire is dependent on how long you have worked at the company and at what salary you are earning when you retire.
Both plans require contributions. That is extremely obvious since without contributions no retirement plan exists. With a defined-benefit plan you are promised a certain outcome. As for the contributions with a defined benefit plan, the employer can make contributions without any money coming from you.
However, the smart employee will contribute to the plan in order to increase their retirement benefit. It is always better to retire with a lot of money in your retirement account no matter what type of defined retirement plans are offered.
Notice that with a defined-benefit plan you receive a reliable income source when you retire. The investment risk to achieve this goal is on the shoulders of the employer or the government.
When you look at a defined benefit plan, on the surface at least, it appears to be the way to travel through retirement. Appears is the operative word. While you bore none of the investment risk while you were working, you now bear several risks.
The plans administrator may reduce your benefits. The company could be in financial trouble and opts to use some of the retirement kitty to help out. The company could also be facing bankruptcy. Regardless of the issue or issues that arise that check you were receiving could shrink.
The other side of the defined retirement plans is the defined contribution side. A 401(k) was cited as an example of such a plan.
With a 401(k) plan, you are responsible for the risk. To some people this is very scary. With this type of plan contributions are also made into the investment pot.
You for sure will be making the contributions. However in some cases your employer will also make contributions based on a set formula. The benefit you will receive at retirement is entirely dependent on how much is contributed over how long a period of time and how the market performs.
Notice the main drawback to this type of defined retirement plans is that you are at the mercy of the markets. Another disadvantage is the cost of the plan may be exceptionally high. As the fees and charges go up, your return goes down.
Because your plan will be investing in market securities, you want the ability to choose the investments you will hold in your account. This means you have to become investment savvy. Some people think you should be investment savvy regardless.
There are other options available to you like an IRA or a Roth IRA. Neither of these is technically considered one of the defined retirement plans. One could argue otherwise but the amount you can contribute to either are so low in comparison it nullifies any argument.
Now you know there are two types of defined retirement plans. The one you have may be the only one your employer offers. Get familiar with it and learn its intricacies. Just because there are only two types of defined retirement plans doesn’t mean you shouldn’t be knowledgeable about your retirement account.
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