When it comes to retirement planning, two key terms can make a huge difference in how much you have to live on after leaving your career: defined contribution and defined benefit.
What do these mean? What's the difference? And how should you account for them during retirement planning? Here's what every American saver needs to know.
What Is a Defined Benefit Plan?
Defined benefit plans used to be largely the norm for employers. These are often called pensions, and they provide a set dollar amount or percentage of your income each month when you retire.
A pension, or defined benefit plan, tells workers upfront what they will receive in retirement. However, how much they and their employer contribute toward this is usually not up to the worker.
What Is a Defined Contribution Plan?
Defined contribution, on the other hand, is a more DIY approach to retirement paychecks. For most American workers, this is your employer's 401(k) plan. However, you may also have access to other plans, such as 457(b) and 403(b) plans for specific employers.
In this plan, you contribute according to your own needs and abilities but are not guaranteed a particular income during retirement. You get out what you contribute.
Is One Type of Account Better?
Now that you know the difference, you may wonder if you should favor one plan or the other. Traditionally, defined benefit plans provided more security for American retirees because this income is more stable.
However, few of today's workers have access to these plans — so you may not have much choice. And many defined benefit plans do not cover all the retiree's financial needs.
Why Should You Maintain Both?
The best approach to both defined benefit and contribution plans is a hybrid retirement plan. If you work for an employer that offers pensions, this is a good way to add a predictable, inflation-adjusted check each month in retirement.
But don't rely on pensions alone. You can usually contribute to other plans, including a 401(k) and/or IRA account, at the same time. This is the best way to diversify your retirement sources.
Where Can You Learn More?
Do you have access to a defined benefit plan? Should you find an employer who offers them? And if so, how can you fund other retirement plans as well? Start finding answers to these questions by meeting with a retirement planner in your state today.
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