Defined Benefit Pension Plan vs. Defined Contribution Pension Plan?

What is a Defined Benefit Pension Plan

Defined benefit plans enable employers to provide ongoing benefits for those who’ve worked for them, even after they’ve retired. So what is a defined benefit pension plan, exactly? Keep reading to learn what you need to know about this employer-sponsored benefit and how it can help you remain stable during retirement.

What is a Defined Benefit Pension Plan?

Defined benefit plans are designed to help members access income after retirement and they do so by providing a defined pension income at the end of their employment. Employers work with a group benefits provider to offer this benefit to long-term employees as part of a comprehensive compensation package.

Calculating pension amounts under these plans can be complicated and while some variances can be seen from provider to provider, they’re generally calculated based upon the following factors:

  • Length of service for your employer
  • Length of membership in the pension plan (typically, this is the same number as length of service but it can vary if an employer changes benefit providers)
  • Average income while employed in the same role

Defined Benefit Pension Plan vs. Defined Contribution Pension Plan

While some employers provide defined benefit plans, others may offer defined contribution plans. The difference between defined benefit and defined contribution pension plans is that, instead of providing a defined income after retirement, a defined contribution plan empowers an employee to contribute a fixed percentage of their income to their benefit. The employer then deposits that contribution on their behalf. In many cases, the employer will match contributions up to a pre-specified percentage as part of its compensation package.

Who is Eligible for a Defined Benefit Plan?

Most often, plan providers and employers require employees to work for the company for a minimum number of years before they are eligible for defined benefit plans. This length of time can vary depending on the employer and the plan provider.

Pros and Cons of Defined Benefit Pension Plans

There are several things about defined pension plans that make them a great addition to employee compensation packages. Here are some pros of defined benefit pension plans:

  • They secure retirement income for the remainder of your life
  • Your employer takes on the responsibility of making contributions to ensure you’re paid an income during your retirement years
  • If enough funds aren’t contributed to cover your pension, your employer is responsible for making up the difference
  • The amount you’re paid is contingent on your best income years during your eligibility period

Of course, as with any type of financial benefit, there are some potential drawbacks to this type of pension plan:

  • You typically need to work for your employer for a minimum length of time before you’re eligible
  • Your employer determines how funds are invested, giving you little control over your future income
  • You can’t contribute additional funds to your pension plan beyond the amount agreed upon in your employment contract

The Bottom Line

While defined benefit pension plans can provide you with a secure income after retirement, they don’t generally come with the same flexibility that RRSPs, TFSAs and other personal investments provide.For more information about group benefits, including defined benefit pension plans, contact DBA to schedule a meeting with one of our experienced experts.

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