‘Tax Explainer: Contribution vs Benefit Plans’
Understanding the differences between a defined benefit plan and a contribution plan will help you determine what's best for your business retirement plan.
2 min read

Education

18 December 2023

Tax Explainer: Contribution vs Benefit Plans

Angie M Grainger

When thinking about business retirement, understanding the difference between these two common categories of plans is key to making the right decisions for the future you want.

The main differences between defined benefit plans and defined contribution plans lie in how they're structured and how benefits are determined.

Benefit plans focus on a target at the end, where contribution plans focus on what's being contributed today.

Why choose a Benefit Plan?

  1. Benefit Promise: These plans promise a specific benefit amount to employees upon retirement. The benefit is typically based on a formula considering factors like years of service and salary history.

  2. Employer Responsibility: Employers contribute to and manage the plan, taking on the responsibility for providing the predetermined retirement benefit to employees.

  3. Investment Risk: The employer bears the investment risk, ensuring that there's enough money in the plan to pay the promised benefits, regardless of how investments perform.

  4. Regular Payments: Benefits are often paid out as monthly payments for the retiree's lifetime, providing a stable income stream.

Why choose a Contribution Plan?

  1. Contributions, Not Benefits: These plans specify the contributions made by both the employee and employer but do not guarantee a specific benefit amount upon retirement.

  2. Individual Accounts: Each participant has an individual account, and contributions, along with any investment gains or losses, determine the account's value.

  3. Investment Responsibility: Participants bear the investment risk as they decide how to invest their contributions among the plan's available options.

  4. Portability: Participants can usually take their account balance if they leave the company, giving them more control and portability of their retirement savings.

We use these plans to help business owners save taxes and save for their future.

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