When it comes to company-sponsored retirement plans, two common types are often implemented: Defined Benefit (DB) and Defined Contribution (DC) plans. The way these plans operate differs significantly. A DB Plan provides a retirement benefit based on an employee’s final salary and length of employment, while a DC Plan offers a retirement benefit based on accumulated contributions and any earnings on those contributions.
Under a DB Plan, the retirement benefit payout is directly tied to the employee’s final salary. As the final salary increases, so does the retirement benefit. Additionally, any salary increases have a retroactive effect on the benefit payout, meaning the employee receives a higher benefit based on their past salary increases. In contrast, a salary increase would only affect the DC Plan prospectively. As the employee’s salary increases, the contribution to the DC Plan also increases.
Determining which plan provides a higher retirement benefit payout is not a straightforward matter. It depends on several factors, including the specific contribution rates for DC plans and benefit factors for DB plans. If these factors are set to be equal—for example, if the contribution rate for the DC Plan corresponds to the benefit factor of the DB Plan—then the DC Plan has the potential to generate a higher retirement benefit if the average annual return on investment surpasses the average annual salary increases of an employee.
Therefore, it is crucial for companies to consult with actuarial experts when considering the establishment of their own retirement plans. These professionals can provide the necessary financial projections and insights into the implications of setting up a company-specific retirement plan. If your company is interested in establishing such a plan, please email email@example.com.