Pension plans can be defined as either defined benefit plans or defined contribution plans. Defined benefit plans provide a combination of benefits, while defined contribution plans rely on employee and employer contributions. Defined benefit plans can face issues with underfunding, compliance, and inflation, while defined contribution plans require voluntary payments and higher administrative expenses.
All pension plans are designed to provide income and security for workers after they reach the end of their working lives and retire or in the event of a disabling injury. The means used to provide that security vary widely between plans, but there are two broad categories of pension plans, both with merits and with flaws. Defined benefit plans provide a combination of benefits, usually including a cash payment and some additional benefits, often in the form of health coverage. These plans continue to pay for the life of a retiree and sometimes their spouse as well. Defined contribution plans rely on both employee and employer contributions to build a balance, which is then withdrawn after retirement.
The key advantage of a defined benefit plan is the fact that it continues to pay benefits, even for very long-term employees, who might otherwise deplete their account balances. Defined benefit pension plans also minimize the risks imposed on a system by poor savers, who might underfund their defined contribution plans and not be able to support themselves in retirement. The combination of services and benefits associated with some defined benefit pension plans, which may include things like discounted travel or admission to museums, especially in European countries, may also serve to keep the elderly more integrated into their societies and thus therefore happier and healthier. .
However, this type of pension plan has become less popular in recent years due to several potential problems. The biggest problem facing defined benefit plans is the issue of lack of funds. Corporate and government pension plans are often underfunded to a sufficient level to keep up with the pressures placed on them by retiree populations, which means that the plans become less and less creditworthy over time and can eventually fail. Corporations and sometimes government entities also sometimes fail to comply with these plans, leaving retirees without any pension. Inflation can also be a problem with these variety of plans, as a high rate of inflation quickly erodes the real purchasing power of a defined benefit.
Defined contribution plans have a different set of advantages. Since the money in these plans is managed by the workers themselves, they are not vulnerable to underfunding by employers. These plans are also portable, which is an advantage in a world where few workers spend an entire career with a single employer.
However, there are also problems associated with defined contribution plans. If workers choose not to pay such a plan, and the payments are often voluntary, then they will have no retirement funds when they finish their working lives. The distributed nature of defined benefit plans means that they also require a higher degree of administrative expense, which means more money spent on fees to fund managers and brokers and less money for retirees.
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