Question

What are the major differences between defined benefit pension plans, defined contribution plans and 401k accounts? Which would you prefer and why.

Answer 1

A defined benefit pension plan is a pension plan in which the employers promise a specified amount either as a lumpsum or as an annuity plan to the employees at their retirement as their pension fund. In this type of plan, the employer contributes all the money to the pension fund and the final amount is decided by taking into account several factors, like the length of employment and salary history of the employee.

Whereas, in a defined contribution plan, the employee makes the contribution to the fund as a percentage of his income, while the employer usually tries to make an equal contribution to the pension fund. The is no definite amount that the employee will receive at their retirement as the return on investment on such a fund is not fixed.

401k is an example of a defined contribution plan. As such the employee contributes a certain portion of his salary to the account while the employer tries to match that contribution.

I would prefer the defined benefit pension plan. Such a plan requires no contribution from the employee and at the same time, the final receivable amount at retirement is known beforehand. A defined-contribution plan, on the other hand, doesn't guarantee any fixed retirement amount and the employee has to make a substantial contribution to the retirement account over the course of his working life.