Contrast Of Contribution Plans With Defined Benefit Plans Accounting Essay


Every one need the security of future in order to survive and enjoy the benefits from the amount that one collect from its life time work. After retirement from the work place the person can enjoy benefits with the retirement planning that one planned in order to achieve its benefits in the future. Retirement planning is basically the financial planning for the retirement. This is important to retain financial independence after retirement and to ensure a secure life which can full fill the financial needs after retirement. Many retirement plans are organized depend up to the organizational requirements to ensures the beneficial retirement schemes for there employees. Defined benefit plan and defined contribution plans are the important types of these retirement plans that benefit the individual after retirement. (Stock & Wise, 1988).

Defined benefit plans

It is the types of benefits that are offered to employees depend on the pre decided formula to determine the amount of benefits given to the employees. Many factors determines the formula for benefit plan includes amount of salary at retirement, number of years employee worked in an organization, etc. the traditional benefit plan formula is the product of three important factor including the number of years employee work in an organization, employee salary at the time of its retirement and accrual rate. In this way the final accrual amount is calculated that will be paid on monthly basis or paid in lump sum. (Frank, 2002).

Defined contribution plan

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Defined contribution plan is the contribution for each employee that will be paid in the individual account. It is the investment of the employee in some program in order to get return that will secure in employee account and provide the benefits at the time of retirement. E.g. the contribution of employee in stock exchange market is made and the return on the investment will be submitted in individual employee account depend on the return on investment. The amount collected in the account through contributions is then provided to employee in the form of employee benefit in future. It can also be paid in the form of annuity which will be paid in the form of periodic payments to the employee mainly on monthly basis. The employee with his contribution plan has the authority to plan and make investment decision and the sponsor of investment also have the significant degree of responsibility for choosing the right investment option.

Contrast of contribution plans with defined benefit plans

Defined benefit plan is the contribution from the employee salary and defined contribution plan is the contribution of employee's investment. Both work well in order to provide benefits to employees after their retirement. Both are portable enough to provide benefits to employees after their employment period will be over. In some places defined contribution plan has more advantage over other as in defined contribution plan the employee has power to take investment decision that will in return have the opportunity to provide significant benefit in future to enjoy the high returned benefit plan that is not available in defined benefit plan. (Bodie, Marcus & Merton, 1988)

In defined contribution plan the cost of administration is reasonable to make this plan more portable as compare to defined benefit plan. The cost of defied benefit plan is not easy to calculate because it needs the software or formula implementation in order to measure the cost. In the contribution benefits there is an ease of cost administration.

There is an ease to choose the sponsor's liability in order to make investment and there is the ease to determine the sponsor responsibilities for contribution plan and the rights to make the major decisions regarding investment is centered on the decision of employee. In benefit plan the employer has most of the rights centered on it and the employee power is limited in deciding the contribution for the salary. (Clark, 1999).

In defined contribution plan the risk and return of investment has to bear by the employee or retiree and not by the employer but in defined benefit plan the most of the responsibilities have to bear by the employer to plan and implement the benefit plan for employ retirement.

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The benefit plan is usually secured because there is no risk of investment and the return is certain as compare to contribution plan where there is the need to take investment decision and uncertainty is associated with investment so there is the association of risk with contribution plan investment which causes uncertainty of return.

Cash balance retirement

Cash balance retirement is the benefit plan which credits the account of employee with percentage of some amount employee's salary and the interest charges as well. Cash balance plans includes the fix rate of return that is credited to the employees account that can be change from year to year. It seems like a defined contribution plan but in actual it is defined benefit plan and the cash balance plan is mostly resulted from the conversion of traditional defined benefit plan which have many controversies that makes the conversion slow. Recently legislation has been passed to clear the process to plan sponsor in order to adopt cash balance plan. (Forman & Nixon, 2001).

Controversies related with cash balance retirement

Many controversies are relate to the cash balance plan as the changed in tradition defined benefit plan to the conversion in cash balance basically has some adverse effect on worker retirements benefits as the As the government Accountability Office of US which is the evaluation and investigating firm of US has released a report to show the effect of Cash balance plan as compare to traditional defined benefit plan and analyze that the cash balance plan has providing lower benefit plans for the workers as compare to the benefits provided to the workers in traditional benefit plan.

For example in cash balance retirement plan the benefits reduce more for the older workers as compare to the younger worker because the contribution for the older and younger workers are made in the same rate in cash balance plan and the amount contribution by the younger workers are accumulated more time before retirement because of long time period of stay in the job as compare to the older worker so the benefits are more valuable for them. The older workers can not get significant benefits from cash balance retirement plan as compare to the traditional benefit plan in which the value of benefits paid on the basis of final average pay of the worker that can be more valuable for the older workers as their salary accrue the benefits faster.

Another example of the controversies arise from cash balance retirement plan is the violation of employee Retirement Income Security Act (ERISA). (Zelinsky, 2001). Many older workers have filed the suits against the conversion in cash balance retirement plan in Congress because of their decline benefits that are the unjust situations. Government choose the lenient approach in this matter as the legal body has realized the situation and analyzed that the economy is at boom and it dint want to limit the organizations to restructure its benefits plan. The legislation has been passing to plan the sponsor for cash benefit plan adoption.

Cash balance retirement plan also breaks the spirit of laws that protects the employees against age discrimination. The Law based on Older Workers Pension Protection Act of 1999 is formed for the protection of older workers benefit. Senator Tom Harkin critically evaluate the cash balance retirement plan and criticize that the cash balance plan is cheaply converted as compare to the funding of traditional benefit plan so that's the reason that most of the employers are converting in cash balance plan. He argued that the plan can be maintained but it should not effect the basic benefit consideration.

Another example of controversial aspect of cash balance is that in the planning of cash balance no individual employee or retiree decision is involved so employer or sponsor has to make the investment decision so they have to bear the risk if investment planning fails.


The retirement benefit plans are important for employee's future security and funded the employees with the monetary needs after retirement. These benefits are the key hold by the employees in order to receive the future security. The different types and style of benefit plans are provided in order to maintain the pace of installments periodically and leverage the interest on it. Defined benefit plan and defined contribution plan are the important types of plan that large numbers of organization are structuring in order to meet the employee satisfaction and to motivate them to whole heartedly contribute in organization. Trend of defined contribution plan is increasing in past recent years due to more chances of return and ease of manage the cost but all these new benefit plans are composed on the basis of traditional benefit plans. The controversial issue of cash balance retirement plan is closely considered in order to coop with the issues of old workers benefits plan. For this purpose legislations have passed to secure the old workers rights, the over all impact of cash balance plan. Cash balance plan provides the benefits of low investment risk as there is pooled of investment made in cash balance plane that reduce the investment risk and provide valuable return.

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