Qualified pension plans can be either a defined benefit plan or a defined contribution plan. There are two types of defined benefit plans: defined benefit pension plans and cash balance pension plans. There are two types of defined contribution pension plans: money purchase pension plans and target benefit pension plans. This week, we discussed the differences between defined benefit pension plans and defined contribution pension plans.
There are many distinguishing characteristics that separate defined benefit pension plans and defined contribution pension plans. The use of an annual actuary is one difference between the two. Defined benefit plans do use an actuary annually while defined contribution plans do not. The money purchase pension plan uses an actuary at inception but does not require one annually. In a defined benefit pension plan the employer bears the investment risk while in a defined contribution plan the employee is the one who bears the risk. The unvested portion that is forfeited is reduces the plan cost in both plans but only the defined contribution plan can allocate plan costs to other participants. Pension benefit guarantee corporation insurance covers only defined benefit pension plans. If an employee has prior service credit then it can be accepted under the defined benefit plan; however, it cannot under the defined contribution plan. A defined benefit pension plan uses the offset and excess methods for social security integration. The offset method reduces the benefit to those employees whose earnings are below the Social Security wage base, which was $113,700 in 2013. Conversely, the excess method provides an excess benefit to those participants whose earnings are above the Social Security wage base. Defined contribution pension plans can only use the excess method. The last difference between the two is that defined contribution pension plans may have separate investment accounts while defined benefit pension plans commingle the accounts.
There are many distinguishing characteristics that separate defined benefit pension plans and defined contribution pension plans. The use of an annual actuary is one difference between the two. Defined benefit plans do use an actuary annually while defined contribution plans do not. The money purchase pension plan uses an actuary at inception but does not require one annually. In a defined benefit pension plan the employer bears the investment risk while in a defined contribution plan the employee is the one who bears the risk. The unvested portion that is forfeited is reduces the plan cost in both plans but only the defined contribution plan can allocate plan costs to other participants. Pension benefit guarantee corporation insurance covers only defined benefit pension plans. If an employee has prior service credit then it can be accepted under the defined benefit plan; however, it cannot under the defined contribution plan. A defined benefit pension plan uses the offset and excess methods for social security integration. The offset method reduces the benefit to those employees whose earnings are below the Social Security wage base, which was $113,700 in 2013. Conversely, the excess method provides an excess benefit to those participants whose earnings are above the Social Security wage base. Defined contribution pension plans can only use the excess method. The last difference between the two is that defined contribution pension plans may have separate investment accounts while defined benefit pension plans commingle the accounts.