Quiz 3: Defined Contribution Versus Defined Benefit Plans
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Pension plans also referred to as retirement plans that a type of investment made in order to accumulate funds from the initial stage to secure investor's future. These plans are of two types- 1. Defined Benefit Plan. 2. Defined Contribution Plan. An approach under which the employer's contribution remains fixed and the accumulated fund of such contribution and its benefits are provided to the employee as an investment for its retirement by contributing from its own income. This method is referred to as Defined Contribution Plan. This plan includes various factors that help in determining its retirement benefits. They are - 1. It helps in employers in increasing the employee's productivity by establishing a good relation with them by providing them a share in profit usually referred to as deferred profit sharing. 2. It reduces employers contribution and maximises employees saving. 3. Contribution is made on before tax income. 4. It provides advantage to the employee of taking up their accumulated fund with them in case changing jobs. 5. Risk on such investment and the related rewards in Defined Contribution approach is completely based upon the employees. This factor helps in determining the retirement benefits for this retirement plan.
The results for this question are superimposed on Figure 3-1. It is obvious that the defined contribution plan in this question would be preferred by younger employees. The cross-over point for an employee starting at age 25 occurs between ages 51 and 54, depending on the rate of wage growth. After that point the defined benefit plan is more advantageous for the employee and hence more costly for the employer. Cet. par., this would imply that older employees would be more costly to retain for employers sponsoring defined benefit pension plans.