Question

What are the differences between defined benefit plans and defined contribution plans? In answering this question, explain why a cash balance plan is a defined benefit plan, and why the target benefit plan is a defined contribution plan.

Answer 1

A defined benefit plan is a plan in which the employer contributes money for the employee to receive a set benefit.

A defined benefit plan is a cost to an employer and as a measure of cost reduction many companies have scaled down the amount of contribution per year or eliminated these plans completely.

A defined contribution plan requires an employee to contribute on his own.

A cash balance plan is a plan in which an employer credits an employee's account by a fixed percentage of its salary. It is termed as a defined benefit plan as as changes in the portfolio in which the money is invested do not affect the final benefit to be received by the employee. The company bears any loss/profit.

A target benefit plan is a defined contribution plan as the amount to be contributed is determined by the amount needed each year to accumulate a fund sufficient for a projected retirement benefit. It does not guarantee a defined benefit payment.It depends on the performance of the portfolio.