As employers move away from providing defined benefits pension plans to the more common defined contributions option, workers are irritated by their retirement options. In fact, according to research completed by the National Bureau of Economic Research, only 16 percent of U.S. employees had access to DB plans, while 42 percent participated in a DC arrangement. Both alternatives have their positive and negative factors. The selection between the two plans is an important human resources issue. Here's what you should know:
Defined contribution plans
Defined contribution plans are the most popular option in today's business world. They allow the employee, employer or both to decide how much money is put toward savings. The figure contributed can change and depends on the amount given by those parties donating funds, as well as any interest that accrues over time.
The most popular DC option is the 401(k), now widely offered by employers, in which employees can set aside money from their paychecks, before taxes, for retirement and employers can choose to match those contributions. These savings are tax-free until a worker retires, upon which the money will be taxed as income.
This option does have its pros and cons for employers and their workers. DC plans benefit companies by keeping costs low; contributions aren't required, nor are matches. For employees, DC selection offers control in the amount and location of money invested. Furthermore, the funds are portable, meaning the contributions will transfer when a worker changes jobs. Yet control can often be a disadvantage with this type of plan as well. Many employees either choose not to invest in a DC plan or save to little to cover their retirement needs.
Defined benefit plans
By choosing this option, employers promise to provide employees with a fixed, monthly sum of money to be put toward retirement. The figure is decided by a formula, which takes into account a worker's earnings, age and amount of time at a company. Similar to the DC option, DB plans are also not taxed until an employee hits retirement. Although DB plans have been the popular choice in the past, especially for companies in the public sector, this type of retirement plan is also the most costly, according to the Internal Revenue Service. Likewise, it perpetuates an age bias: as employees grow older, they stand to make more money from DB plans than young workers.
The DB selection is not without its employer advantages, however. This type of retirement arrangement allows companies to put more money into a worker's pension, thus resulting in a larger tax deduction. Additionally, since the amount of money is based on a formula, businesses are aware ahead of time how much money they'll be saving for their employees.
For employees, a disadvantage of the DB option is also an advantage. According to CNN Money, one of the downfalls of this selection is the lack of control workers receive over how much and in what way their money is invested. On the flip side, it requires retirement funds to be put away on the employee's behalf, leaving no room for forgetting or declining a contribution.
Too many options results in inertia
While both types of plans offer retirement savings, the complicated nature of these options can often cause workers to hesitate, the National Bureau of Economic Research study found. Instead, human resources should narrow down the choice for employees, including the method in which people opt in to these plans. Automatic enrollment was discovered to be the best tactic for participation. Furthermore, immediate enrollment paired with auto escalation of savings rates increased the employee participation even more, as many workers won't opt out of this dual-method.
Offering employees too many choices for enrollment was the downfall of company-sponsored retirement plans. The complexity of the employee's selection led workers' actions to waver.
Human resources teams should weigh the pros and cons of employee pension plans when deciding which option to choose. Following the employer's selection of either DB or DC option, HR should make sure the details of the selection are communicated to all employees, including the reasons for selecting the particular plan. Lastly, a clear-cut enrollment process should be outlined to ensure as many workers as possible are preparing for retirement.