Defined Benefit vs. Defined Contribution Pension Plans

Emily J. Schmale

Author: Emily J. Schmale

POST DATE: 11.14.23
Ccha  Family Law

Understanding your pension plan can be a daunting task. If your employee benefits include a “pension”, and especially if you’ve been a public employee in Indiana for a while, you’ve likely heard terms like “defined benefit” and “defined contribution” when discussing your retirement plan. However, understanding the differences between these two components can be challenging. There are pros and cons to both the defined benefit plan and the defined contribution plan. In this article, we will delve into these two elements of pension plans so you can make informed decisions about your retirement.

Defined Benefit vs. Defined Contribution Pension Plans: An Overview

A pension plan can, for example the Indiana Public Retirement System (INPRS), have two parts. The first one is a defined benefit plan. The second one is a defined contribution plan.

Defined Benefit Plan

A defined benefit plan aims to provide retirees with a guaranteed and specific income after retirement. Defined benefit plans are also referred to as “traditional” pension plans because of their widespread use over the last century. The employer makes 100% of the contributions in an INPRS defined benefit plan. That contribution rate is determined by a board of decision-makers in the INPRS every year.

The income you receive from a defined benefit plan depends on several factors. These factors generally include your salary, age, and years of service.

Pros and cons

The one major pro of a defined benefit plan is that it provides a secure, predictable income for life. Therefore, there’s little risk of outliving your savings. In addition, you do not have to contribute your own earnings for a defined benefit plan.

Despite these advantages, defined benefit plans have downsides. The main disadvantage is the lack of control. For one, you can’t make individual investment decisions. On top of that, the payment amount is constant. This limits your plan’s potential growth compared to market-based plans.

Piggy bank

Defined Contribution Plan

In contrast, a defined contribution plan is a type of retirement plan where you (and often your employer) both make regular contributions. The INPRS then invests those funds on your behalf. The amount you receive upon retirement depends on the investment’s performance. Because the final balance depends on market performance, defined contribution plans allow potentially higher returns. Generally, defined contribution plans also give you more control over your investment choices. The INPRS defined contribution account allows employees to choose from eight funds:

  • Stable Value Fund,

  • Money Market Fund,

  • Fixed Income Fund,

  • Inflation-Linked Fixed Income Fund,

  • Large Cap Equity Index Fund,

  • Small to Mid Cap Equity Fund,

  • International Equity Fund, and

  • Target Date Funds.

Yet with these additional freedoms comes increased risk. Because of the unpredictable performance of the stock market, there’s a chance your fund could lose value.

How Do Pensions Pay Out?

Pensions often pay out in the form of regular, monthly income. However, some plans offer other options for payout, such as lump-sum distributions or annuities. Lump-sum distributions provide the entire value of the pension in one payment, while annuities provide a guaranteed income for a specific period. It’s essential to understand the terms of your specific pension plan to know exactly how and when payouts will occur.

Mature couple looking at pension plan

Understanding Spouse Pension Rights After a Divorce

In a divorce, vested pensions can be considered marital property. Consequently, courts will divide a pension between spouses, regardless of whether it’s a defined benefit or defined contribution pension plan. However, the methods of division and spousal rights may vary based on the specific circumstances. Unlike some other states, Indiana law allows divorce courts to value the pension accrued prior to the divorce for what it will be worth when the employee retires. A court may also apply a “coverture fraction” and include in the marital estate only the portion of the pension accrued during the marriage. In these situations, a Certified Public Accountant (CPA) can serve as a pension calculator to help the court understand the pension’s future value.

Defined Benefit Plans

With defined benefit plans, the non-employee spouse may be entitled to a share of the payout once the employee spouse begins to receive it. The exact portion the non-employee spouse receives turns on state law and the terms of the final divorce order. In some, but not all cases, a court can grant a non-employee spouse the right to a portion of the benefits payable to the participant through a “Qualified Domestic Relations Order” or (QDRO). The availability of a QDRO depends on the terms of the plan.

Defined Contribution Plans

Because defined contribution plans base their benefit on employee contributions and investment performance, the non-employee spouse can usually receive their share at the time of the divorce. As with defined benefit plans, courts can sometimes use a QDRO to divide the benefits. However, it’s important to remember that these are general principles. Some pensions cannot be divided by a QDRO.

Need More Answers? Call Us Today

Understanding the nuances of your pension plan can be a daunting task. That said, it is an essential part of ensuring your financial security in retirement. Fortunately, you don’t have to traverse this complex terrain alone. Church Church Hittle and Antrim is a well-established law firm rooted in 140 years of legal service in Hamilton County, Indiana. We have the experience and commitment to help you navigate these complexities. Our seasoned attorneys understand Indiana pension law and can help you explore the retirement options that will best serve your long-term goals. Don’t leave your future to chance. Reach out to CCHA Law today to help improve your future retirement picture.