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Making the Most of Your Future: A Quick Guide to Investing in DC Plans
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Defined contribution (DC) plans are fast becoming to working Americans what pensions were to an earlier generation. Such plans first gained favor in the 1970s as a pension alternative for smaller businesses. But today, fewer employers are offering traditional pensions (defined benefit plans or DB plans), and instead offer DC plans.
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There are some fairly significant differences between the two. A DB plan pays you a specific amount of money each year of your retirement based on how long you worked for a company and how much you were paid. The payouts you receive from a DC plan, however, depend on the performance of the underlying investments you've selected.
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Another point of contrast between DC and DB plans concerns how much gets contributed to employee accounts. With pensions, the employer is required to contribute whatever is necessary to meet its obligations to retired employees.
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On the other hand, with DC plans it is up to the employee or company (depending on the type of plan) to decide. In 401(k)s and thrifts, each employee can decide to sock away the maximum allowed, nothing at all, or some amount in between. Similarly, profit-sharing contributions are typically linked to the company's performance and can vary greatly from year to year. Meanwhile, with the money purchase plan the employer is required to place a certain amount in the retirement account each year, usually a certain percentage of the employee's salary.
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It's the flexibility in how to fund the plan—along with freedom from guaranteed payouts and more predictable costs—that have made DC plans popular with a wide range of employers. And as that popularity grows, the number of companies that offer DB plans is declining. The downside for employees is that DC plans often put the onus on them to determine the investment strategy for their account. Many plans, though, are trying to relieve that burden by offering employees managed accounts services, target date funds, advice services, and educational resources. These services are designed to help employees make better and more informed investment decisions.
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