LOS D requires us to:
describe defined contribution and defined benefit pension plans
1. Defined Benefit Plans
a. Defined benefit plans usually involve pension trust where there is a promise to pay a definite level of pension, not directly related to the contributions made to the fund by the employees or the employers on their behalf.
b. The formula to calculate the payments at the time of retirement is based on the earnings of the employee and the length of their service.
c. For example, the employer may have an obligation to pay 2% per year of the last 5-year average wage.
2. Defined-Contribution Plan
a. In defined-contribution plans, the contributions made by or on the behalf of the employee are accumulated and paid on retirement along with such return as may be generated by the fund on the investment made.
b. In such plans, the risk is usually borne entirely by the participating employee as his benefits are directly related to the accumulated contributions to his credit. If the pension or provident fund loses money in investments or earns lower than benchmark returns, the employee bears the loss or opportunity loss.
c. In such plans, the pension amount depends on the amount accumulated to the credit of the employee. Defined-contribution plans can be funded by the contributions of either the employee or the employer or both.
d. The employers, in such plans, contribute either some percentage or some fixed dollar amount.
e. The benefits from such a plan depend upon the contributions, length of investment, and performance of the fund.