Defined Contribution and Defined Benefit Plans
MR. WATSON: Defined benefit plans.
MR. WATSON: These are pension plans. A defined benefit plan defines what, guys?
STUDENT: Defines exactly what your benefits are going to be in the future, at retirement.
MR. WATSON: We're defining what's coming out. What goes in each year is not known.
Defined Contribution Plan
MR. WATSON: Next is a defined contribution plan . What's a defined contribution?
STUDENT: The employer defines the amount they will put in each year, but because they don't know how much it will be worth at retirement, the benefit at retirement will not be known until the employee gets there.
MR. WATSON: Good. Example: You’re putting in whatever amount you’ve allocated to go into your retirement plan. The employer might put in $5,000 a year for you. Just making up a number. It’s usually a percentage of what you contributed or a percentage of your income. Do I know how much that's going to be worth in 30 years?
STUDENTS: No.
MR. WATSON: Maybe it's worth $425,000, how much will you get?
STUDENTS: $5,000 a month, to make up a number
MR. WATSON: OK, if it was more than $425,000, what would you get?
STUDENTS: More.
MR. WATSON: If it was worth less, what would you get?
STUDENTS: Less.
MR. WATSON: There are three types of defined contribution plans.
MR. WATSON: P.M.S.
MR. WATSON: Profit-sharing plan . If the business has a profit, the business shares that money on your behalf. What if we don't have a profit? No money in.
MR. WATSON: Money purchase plan . We're going to use money that is in the bucket, and we're going to do what? Purchase you a benefit. If the money in the bucket is $425,000, we will use that money to purchase you a benefit of $5,000 a month. If the money in the bucket happens to be worth more, we will purchase you a higher benefit.
MR. WATSON: If less, we will purchase you ....
STUDENTS: Less benefit.
MR. WATSON: But with a money purchase plan, even if the business loses money, they still have to put money in on your behalf. Which would you rather have as an employee-money purchase or profit-sharing?
STUDENTS: Money purchase. They guarantee to put money in my retirement account.
MR. WATSON: Stock bonus plan . This is similar to a profit-sharing plan. Instead of putting money in, they put in company stock. What would you think of that, if you worked for me?
STUDENT: No way, Jack.
MR. WATSON: Defined benefit & defined contributions. Important: Profit-sharing and money purchase are examples of what kind of contribution plans?
STUDENTS: Defined contribution.