What is defined contribution plan?

In Investment by CreatingWealthYoung0 Comments

Defined contribution plans are far more common today than defined benefit plans. Their popularity is due to a couple of factors; lower investment returns, increased costs, and greater life expectancy. Given the current economic conditions and longer life expectancy, most employers would rather help their employees save towards retirement rather than be responsible for helping and funding their retirement.

What is a defined contribution plan?

A defined contribution plan allows an employee to contribute a certain amount of their yearly earnings towards their retirement. At the same time, an employer matches a certain percentage of the employee’s contribution to further help the employee build up their retirement fund.

The employee is responsible for selecting the type of investment that will help them meets their retirement objectives. All the investment risk falls on the employee. The type of pension income an employee can expect depends on how their investment has done.

What are some of the benefits of a defined contribution plan?

Defined contribution plans provide greater flexibility for an employee who wants to manage their retirement investment account. As such, the employee can select from a range of investment option that will suit their risk profile and investment objectives.

An employee’s retirement income will be the amount of money they’ve managed to save before retirement and the corresponding income they are able to generate from their investment. During retirement, they will live off whatever their investment is able to provide them and the employer isn’t responsible for an additional pension income or any pension shortfall.

What you need to pay attention

Fees. More accurately management expense ratio (MER) attached to the investment option your employer provides you. While employers offer a host of investment option, from my experience, most of the investment plans offered by employers who offer defined contribution plans have high investment fees.

That being the case, pay attention to the fee because fees can eat away at your retirement money. Secondly, avoid just selecting the default plan. Take the time to select the right investment that’s appropriate for your risk and investment objectives. There’s a high probability the default investment profile will not meet or suit your investor profile, yet most employees are overwhelmed and simply select the default plan. Take the time to find out about your option and ask questions.

Defined contribution plans offer greater flexibility and control over the type of retirement investment you hold. The trade off is that you are responsible for the amount of income you can expect upon retiring. Don’t panic, take your employer’s contribution and invest for the long run. Keep an eye on your fees and ensure you take the time to go through all your employer investment option available.