Pension plans are getting harder to define. If you don’t get the definitions right, the confusion can be quite (re)tiring.
What’s in a definition? That depends, in part, on what you’re trying to define.
When it comes to pensions, there are two important definitions:
- Defined Benefit Plans are retirement accounts, into which an employer puts money. Benefits are calculated on a number of variables, including years of service, average salary in the last years of employment, and others.
- Defined Contribution Plans are retirement accounts, into which employer and employee contribute money. Benefits are calculated on a number of variables, including the number of years contributed to the plan, the amount contributed, the amount the employer matches (if any), the way in which your investment fund (or funds) performs, and others.
Because of the administrative burdens, the expenses and the long-term commitments required of Defined Benefit Plans, fewer employers and pension administrators are offering them. Defined Contribution Plans let employers contribute less, offload the administrative burdens, and be clear of the investment decisions required to manage their employees’ pension money.
In the Netherlands, legislation effective September 2016 (“Wet verbeterde premieregeling” Staatsblad van het Koninkrijk der Nederlanden, jaargang 2016, 248) gave employees reaching retirement age the ability to choose what they want to do with the money in their pension plans. They can opt for several products with fixed or variable payouts, depending on their wishes and needs.
While it’s positive to give employees the flexibility to choose, there’s one major consideration inherent in the choice:
Because Defined Contribution Plans come without applicable benchmarks, employees may be at risk of underfunding their plans — and, so their retirements — especially if their contributions and their employers’ aren’t carefully calculated over the term or expected term of employment. Employees may also be at risk if the earnings on their investment funds aren’t projected accurately, especially if their funds are invested in high-risk instruments. While most Defined Benefit Plans target replacing 60 to 75 percent of employees’ working incomes, Defined Contribution Plans have no such targets.
If you’re in the business of pension funding, you have as many variables to consider as the employers and employees you serve. Before deciding on the types of plans you’ll fund, make sure you know what’s in a definition and how you plan to administer the funds you provide.