In the broad landscape of retirement planning, two distinctive types of plans come into play – Defined Benefit Plans and Defined Contribution Plans. This differentiation essentially revolves around who assumes the investment risks, who funds the plan, and how administration costs are managed. Both types of plans are often referred to as superannuations.

Key Players Behind Defined Benefit Plans

Historically, behemoth corporations such as General Electric and General Motors were amongst the prime facilitators of Defined Benefit Plans. However, the long-term burden of guaranteeing the performance of these plans resulted in a significant strain on their profitability. If the plan failed to perform as per assumptions, the corporations had to shell out the difference from their profits. As a result, most companies today prefer Defined Contribution Plans, which shift the burden of performance to employees, over Defined Benefit Plans.

That said, Defined Benefit Plans haven't entirely disappeared from the retirement planning landscape. Some key players still offer these plans, particularly within union groups. Collective bargaining has been leveraged to establish Defined Benefit Plans across multiple employers. These multi-employer pensions, especially union arrangements, have however faced substantial challenges to remain fully funded up to actuarial standards in recent decades.

The Trade-offs Between Defined Benefit and Defined Contribution Plans

Defined Benefit Plans, financed primarily by employers, promise a specific retirement benefit amount for each participant. In contrast, Defined Contribution Plans are largely funded by employees. They defer a portion of their gross salary into these plans, and employers can opt to match the contributions up to a certain amount. The 401(k), a popular example of a Defined Contribution Plan, signifies the noticeable shift of companies favoring these plans over their defined benefit counterparts.

The trade-off here lies in who shoulders the investment risks. While employers bear the brunt of investment risks in Defined Benefit Plans, employees bear this burden in Defined Contribution Plans. This shift of risk from employer to employee is why individuals must be informed and active participants in their retirement planning.

Advice for Smaller Businesses and Low-profit Entities

An essential point to consider is that not every organization is suitable for providing Defined Benefit Plans. Particularly for smaller businesses or those with a slim profit margin, setting up a Defined Benefit Plan might not be a viable option. These plans carry higher administrative costs compared to other retirement plans, and when underfunded, can trigger excise tax. Thus, for businesses with limited resources, adopting Defined Contribution Plans is a more feasible path toward retirement planning.

While Defined Benefit Plans have dwindled in popularity due to their high-cost nature and investment risks, they are still being offered by union groups and some large corporations. Nevertheless, with the increasing favorability of Defined Contribution Plans, employees are now taking a more front-seat role in their retirement planning.

Summary:
Any employer can offer a Defined Benefit plan, but not many do anymore.

Before the introduction of Defined Contribution Plans, most large corporations such as General Electric, General Motors, etc. offered only Defined Benefit Plans. Over the years, it has put a huge burden on these corporations to guarantee the performance of these plans.

If the plan has not performed according to the assumptions, the company would have to contribute the difference, which would have to come from their profits. In order to shift the burden to the employees, most companies now offer Defined Contribution Plans (such as 401(k)s, etc.) instead of Defined Benefit Plans.

The plan participant bears the investment risk in defined contribution plans. This is why it has become so important for you to be an informed and active participant in your retirement planning.

See our articles about defined contribution plans for more details (located in the ‘Retirement Accounts’ section).

Pensions have always been popular with union groups, and they use collective bargaining to set up plans across multiple employers. Many pensions, especially multi-employer pensions such as union arrangements, have struggled to remain fully-funded up to actuarial standards in the last decade or two.

Businesses which are not very large or who do not have a significant profit margin should not attempt to use a defined benefit plan. An excise tax will apply when the plan Is underfunded, and the administrative costs of defined benefits plans are higher than any other form of retirement plan. (IRS information on Excise Taxes — found here)

How Does a 401(k) Compare With Other Retirement Plans?
How Do I Allocate My Assets in Retirement?