Hello;
Here is a description of each work retirement plan and some key differences:
Defined Contribution Plan (DC)
This plan is one where contributions into the plan are based on a specific formula and the sum of accumulated contributions and growth, credited to a plan member, are used to purchase a pension at retirement. This is very similar to an RRSP, where the deposits are known, the plan member retains investment risk and the accumulated assets are used to provide a retirement income. Contributions into a D/C plan include required employer contributions. If the plan is contributory, then employees also contribute on a regular basis. Contributions are allocated specifically to each plan member where the member's funds are held and earn an investment return. The amount of retirement income from participation in the plan is dependent on the balance of funds accumulated in the plan, which is not known until the actual retirement date. Thus, while the required contributions are a known quantity, the ultimate benefit is unknown.
An inherent characteristic of a D/C plan lies in the fact that the plan member assumes responsibility for the investment risk. This completely contrasts with a defined benefit plan where the employer assumes the investment risk by committing to the necessary funding to support a specified retirement benefit.
Given that the employee assumes the investment risk in a D/C plan, it is common for the employee to actively participate in all the investment decisions for the funds in his/her retirement account. The pension plan usually has an array of investment options available to plan members, and the plan member is free to direct his/her funds into investment vehicles that suit his/her risk preferences. The employee's retirement pension is directly dependent upon the investment performance of the pension plan's assets. If the investments perform well, the employee's retirement pension will be larger than if the investments perform poorly.
Defined Benefit Plan (DB)
This plan provides pension benefits based on a defined formula where the benefit is known in advance of a participant's retirement. The formula for calculating the benefit is defined within the pension plan documents and provides the plan member with a good estimation of the level of retirement income that he/she can expect from the pension plan. Three common types of formulas used in D/B plans are: (A) Final Earnings or Best Average (B) Career Average or (C) flat benefit. For this plan, both employer and employee contribute. Within this plan, because the plan sponsor is responsible for the solvency of the plan, investment decisions lie with the plan sponsor and subsequently, the plan sponsor has full responsibility for the investment risk. The plan member's pension is guaranteed and is not dependent upon investment decisions, as the plan sponsor must provide the accrued pension regardless of the plan's investment return. This places a significant financial responsibility on the plan sponsor, usually the employer and results in a worry-free pension for the plan member.
If you require further information, please feel free to contact us
Sincerely,
Mike Busby
