Understanding Deferred Pension Plans: Defined Benefit vs. Defined Contribution

There are two types of deferred pension plans available to employees. A defined benefit plan specifies the amount of money you will receive during retirement, and this amount is guaranteed by the employer. A defined contribution plan guarantees a certain contribution will be made on your behalf. Your total retirement benefit, however, is not guaranteed.

Function

A deferred pension is a pension that your employer funds on your behalf. In this respect, your employer is taking a paternalist role with regard to his employees by taking care of them in their old age. Deferred pension benefits are designed to make up a substantial portion of your retirement portfolio.

Benefits

You get "free" money from your employer. This money is retirement income that generally does not come out of your paycheck. Instead, your employer pays for the pension portion your retirement. If you know that you will be receiving a pension, you don't need to accumulate as much money in your personal savings as you would have to without the pension. This allows you to make other savings goals not related to retirement or gives you an increase in discretionary income, since you won't have to fund personal savings as heavily.

Drawbacks

Your employer typically dictates pension terms. In a defined benefit plan, your retirement income is set, and you can not change this amount. If inflation erodes the value of money significantly, the real value of your pension could be far less than you had hoped. In a defined contribution plan, your employer decides how the money will be invested. If you disagree with the investment philosophy of your employer, you're still stuck with the results of the pension plan. Many times, you may not know how the money is invested.