My Retirement Account is a “Defined” What?
There are two types of employer-sponsored retirement plans:
A defined benefit pension (DB) plan provides a specified payment amount in retirement
A defined contribution (DC) plan allow employees and employers to contribute and invest funds over time to save for retirement.
Defined Benefit Plans: Defined benefit (DB) plans are primarily pension plans or qualified-benefit plans. The term "defined benefit" means that employees and employers know the formula for calculating retirement benefits ahead of time, and they use it to define and set the benefit paid out.
Poor investment returns or faulty assumptions and calculations can result in a funding shortfall, where employers are legally obligated to make up the difference with a cash contribution. There are also restrictions on when and by what method an employee can withdraw funds without penalties. Benefits paid are typically guaranteed for life and rise slightly to account for the increased cost of living.
Defined Contribution Plans: Defined contribution (DC) plans are funded primarily by the employee, called the participant, with the employer matching contributions up to a certain amount. The most common type of defined contribution plan, which many people are familiar with, is a 401(k) plan. A participant may elect to defer a portion of their gross salary through a pre-tax payroll deduction to the plan.
Contributions can be invested at the participant's direction, in select mutual funds, money market funds, annuities, or stocks offered by the plan. The employer has no obligation regarding the account's performance after the funds are deposited, these plans require little work and are low risk to the employer.
The distinction between DB and DC retirement plans can have a significant impact on your options following a divorce. It is not uncommon for one spouse to consider liquidating a portion of a marital retirement fund after a divorce to pay off debt or even make a down payment on a new home. If the retirement plan is a DC plan, the account may be liquidated but could have significant tax consequences. If the retirement plan is a DB plan, liquidation of the Plan will likely be prohibited.