| Making the Most of Your Future: The 5-minute Guide
to Investing in Defined Contribution (DC) Plans |
| Defined contribution (DC) plans are fast becoming
to working Americans what pensions were to an earlier generation.
Such plans first gained favor in the 1970s as a pension alternative
for smaller businesses. But today, even large companies with established
pension plans often provide a DC option as well. |
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| Some companies refer to DC plans internally as pension plans, but
there are definite differences between the two. Pensions are defined
benefit plans--in other words, they offer workers a guaranteed payout
at retirement that can be determined (or defined) in advance. Two
employees with the same years of service and a similar salary history
will generally receive the same pension amount. Employers are exclusively
responsible for funding pensions (employees don't kick in a cent)
and must make regular contributions in good times and bad. |
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| DC plans are another species altogether. Like pension plans, they
place great emphasis on regular contributions, but just who antes
up varies, depending on the particular type of offering. For example,
profit sharing and money purchase plans are funded principally by
the employer. In the case of 401(k) and thrift plans, however, the
main responsibility for keeping the account flush falls to the employee.
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| Another point of contrast between DC plans and their defined benefit
cousins concerns how much gets contributed to employee accounts. With
pensions, the employer is required to contribute whatever is necessary
to meet its obligations to retired employees. |
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| With DC plans, on the other hand, it's up to the employee or company
(depending on the type of plan) to decide. In 401(k)s and thrifts,
each employee can decide to sock away the maximum allowed, nothing
at all, or some amount in between. Similarly, profit-sharing contributions
are typically linked to the company's performance and can vary greatly
from year to year. Contributions to money purchase plans are fixed,
but the employer gets to establish the exact percent of payroll it
has to fork over. |
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| The flexibility to fund plans in a variety of ways--along with
freedom from guaranteed payouts--has made defined contributions popular
with a wide range of employers. But DC plans also offer employees
several important features that aren't available with traditional
pension offerings. |
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