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How does a defined contribution plan work? You build up the pension fund with contributions throughout your career and then it is up to you to make sure that it lasts you till your death?

I am at a job with a defined benefit plan and am being offered a job with a defined contribution plan but higher salary (10% higher). I am not able to make up my mind about whether to switch?

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    Stick with your current DB plan, you will be setfp for life in retirement and not have to worry about the risk of a market crash wiping out your retirement funds. Leave the risk with your employer. – user9722 Oct 22 '15 at 20:28
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The end result is basically the same, it's just a choice of whether you want to base the final amount you receive on your salary, or on the stock market.

Defined benefit

You pay in a set proportion of your salary, and receive a set proportion of your salary in return.

The pension (both contributions and benefit) are based on your career earnings. You get x% of your salary every year from retirement until death.

Defined contribution

These are just a private investment, basically: you pay a set amount in, and whatever is there is what you get at the end.

Normally you would buy an annuity with the final sum, which pays you a set amount per year from retirement until death, as with the above.

The amount you receive depends on how much you pay in, and the performance of the investment. If the stock market does well, you'll get more. If it does badly, you could actually end up with less.

In general (in as much as anything relating to the stock market and investment can be generalised), a Defined Benefit plan is usually considered better for "security" - or at least, public sector ones, and a majority of people in my experience would prefer one, but it entirely depends on your personal attitude to risk.

I'm on a defined benefit plan and like the fact that I basically get a benefit based on a proportion of my salary and that the amount is guaranteed, no matter what happens to the stock market in the meantime. I pay in 9% of my salary get 2% of my salary as pension, for each year I pay into the pension: no questions, no if's or buts, no performance indicators.

Others prefer a defined contribution scheme because they know that it is based on the amount they pay in, not the amount they earn (although to an extent it is still based on earnings, as that's what defines how much you pay in), and because it has the potential to grow significantly based on the stock market.

Unfortunately, nobody can give you a "which is best" answer - if I knew how pension funds were going to perform over the next 10-50 years, I wouldn't be on StackExchange, I'd be out there making a (rather large) fortune on the stock market.

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  • Good answer. I think an additional point could be made on the flexibility of a Defined Contribution scheme. In the UK you can choose, on retirement, to take all of your pension pot as cash straight away, or to put it all in an annuity, or to take it gradually as cash; or indeed any combination of those. Defined Benefit tends to be much more prescriptive: you pay in A%, you will get B% as a lump sum on retirement and C% as in income thereafter. – AndyT Oct 22 '15 at 16:11
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    I think it is quite misleading to say the effect is the same. As you explain later in your answer, they have quite different risk profiles. A defined benefit means you are guaranteed a certain amount of money and can go to court to ensure you get it. A defined contribution plan has no such guarantee. – BrenBarn Oct 22 '15 at 17:14
  • I rather meant that the effect of 'you have some money every month' is the same. In theory, anyway - if pension schemes do so badly that we don't get that, society likely has bigger issues going on – Jon Story Oct 22 '15 at 17:20
  • The end result is not basically the same. With defined benefit the risk is with the employer and with defined contribution the risk is with the employee. That is why they are phasing out defined benefits. If you can live on your current salary i would stick with the defined benefit as you are guaranteed a % of your final salary in retirement. You would probably need to contribute the extra 10% salary and more to get the same result with the defined contribution, and that is if the stck market doesn't crash before you retire. – user9722 Oct 22 '15 at 20:19
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It is comparing apples to oranges. From govt or institution point of view defined contribution is better than defined benefits as they don't have to carry obligations.

Although defined benefit sounds good, one can't guarantee it will be enough when you retire compared to inflation. It often becomes political issue.

Defined contribution puts you in charge.

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  • The second paragraph is a good point, but defined benefit is usually index linked. Admittedly not always, however, and that's definitely something to consider. – Jon Story Oct 22 '15 at 16:42
  • BS, DC only puts you in control of risk. Unless you have your DC retirement funds at risk in the market after you retire, it may be not enough compared to inflation as well. At least with DB you get a % of your final salary. You would need quite a big DC fund and the stock market to continuously perform well ( with no crashes) to achieve the same result with DC. – user9722 Oct 22 '15 at 20:26
  • @GeorgeRenous one has to look at large time scales. In India DB worked great till 2000. However inflation year on year approx 10% and govt not revising, the amount of DB was meaning less. This does not mean DC will be meaning full or make's sense. – Dheer Oct 23 '15 at 2:22

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