Mid-America Pension Rights Project: Defined Benefit Pension vs Defined Contribution 401(k): Part 2

By Christine Steinmetz, Pension Attorney at the Mid-America Pension Rights Project at Elder Law of Michigan

In my last blog post, I discussed a defined benefit pension where the employer solely contributes to the plan and bears all the risk. In this post, I will discuss the defined contribution plan.

A 401(k), also called a defined contribution benefit, is very different from a defined benefit pension. First, with a traditional 401(k), the employee contributes a certain amount out of his or her paycheck each pay period to put into his or her 401(k). Many employers offer a small match to your 401(k) contribution and will have their own vesting rules. However, the money the employee puts into the 401(k) belongs to him or her even if the vesting rules are not met.

Traditional 401(k) plans offer a tax deduction at the time of contribution. The money grows tax-deferred until you take it out. In addition, if the employee needs the money before age 59 ½, then he or she will be subject to a 10% penalty. Further, the employee must begin taking a minimum distribution by age 70 ½, or he or she will be subject to a penalty equal to 50% of the minimum distribution amount.

The downside of a 401(k) is that the employee, not the employer, bears all the risk. If the employee chooses the wrong stock fund or if the stock market declines, the risk falls entirely on the employee. The employee will need to monitor his or her 401(k) funds to make sure he or she is saving enough, and that the funds are doing well. With the defined benefit pension, the employer must make sure the retirement accounts are properly funded and bears the loss if the retirement accounts are not.

With the defined benefit pension, the employer solely bears all the cost of contributing to the plan and bears all the risk. With the defined contribution 401(K), the employee contributes to the plan from his or her paycheck and the employee bears all the risk. Some employers may make a match to the employee’s 401(k), but it is generally a small percentage.

In the future, you are going to see more companies moving away from defined benefit pension plans to 401(k) defined contribution plans to transfer the costs and risks from the employer to the employee.

If you have questions about your 401(k) or defined benefit pensions, please call the Mid-America Pension Rights Project. The Mid-America Pension Rights Project is funded by the Federal government through a grant provided by the Administration for Community Living and is a program of Elder Law of Michigan, Inc., a 501(c)(3) non-profit organization.

Since the program began in 1998, the Pension Project has assisted over 15,000 clients and recovered over 75 million dollars in pension benefits. The Pension Project assists clients that either worked in or are currently living in Indiana, Kentucky, Michigan, Ohio, Pennsylvania, and Tennessee. For more information, visit www.mid-americapensions.org.

If you need help with or information about your pension or 401(k) benefit, please call the Mid-America Pension Rights Project at 866-735-7737 to schedule an appointment with one of our experienced attorneys.

The information in this article is general and not intended to be a substitute for legal advice. In any legal matter you should always consider consulting with an attorney for specific advice.

Christine Steinmetz is a part-time Attorney at Elder Law of Michigan and has been a member of the Elder Law team since 2011. As an attorney at Elder Law, Christine advises clients on pension benefit issues.