Understanding Defined Benefit Pension Plans
This is the second post in a two-part series on different categories of tax-advantaged retirement plans: defined contribution and defined benefit. You can read our breakdown of defined contribution plans here.
These two types of retirement accounts are primarily differentiated based on the process in which they are funded, as well as how participants are paid out benefits.
How does this matter within the context of precious metals bullion investing? The type of plan(s) that you participate in have an impact what investable assets you can contribute funds to. Different plans have different rollover rules, too, and your ability to protect your investment portfolio with a 5-20% allocation to precious metals is affected by the plan that you enroll in.
Here, we’ll detail what a defined benefit plan is, how it works, who offers them, and how you can add gold or other precious metals to your plan.
Defined Contribution vs. Defined Benefit Plan
Defined benefit plans act like traditional pensions — a certain guaranteed level of retirement income is made available to employees based on a formula. This formula usually will take into consideration the level of compensation during an employees working years, how long they worked for a given company, and (in a less direct sense) the profitability of the company.
Defined contribution plans are structured so that the employee, employer, or both can make contribution (usually on a consistent, recurring basis) to a tax-deferred growth vehicle. These plans identify how much money is going to be contributed towards retirement today, not how much money will be available as a guaranteed benefit in retirement.
Most defined contribution plans offer a set of investment options which the account owner can choose from, have an IRS-imposed contribution limit, and assess a penalty on any money that is withdrawn before retirement age (usually 59.5).
Defined contribution plans provide investment control, in varying degrees, to the employee. In so doing, the employee assumes the investment risk, meaning that they have a significantly higher risk-reward factor than defined benefit plans.
Who Offers Defined Benefit Plans?
Defined benefit plans initially gained popularity during the Second World War, at which time the federal government instituted price and wage controls on a host of industries. Not able to offer increased wages to entice employees to come work for them, companies began to offer larger non-wage compensation plans — especially retirement benefits.
The rise of defined contribution plans has prompted many private companies to transition away from defined benefit pension plans. This is primarily because the costs and risks to the employer tend to be smaller with a defined contribution plan like a 401(k) or IRA.
Today, most defined benefit plans are found with governments and public entities, although a number of corporations do offer them. You are more likely to see defined benefit pension plans established by companies with unionized labor.
Note that defined benefit plans do not encompass all pensions funds that employers offer, many of which have investment-return dependent payouts. Instead, both private and public defined benefit plans create formulas to calculate individual retirement benefits.
Defined Benefit Plan Rules
While companies in the United States have some discretion over their specific benefits calculations, the maximum allowable annual benefit in 2014 is $210,000, per IRS rules. If an employee is allowed to make contributions to the plan (which can be rare), there are no contribution limits.
Plans must allow vested employees to receive benefits no later than 60 days after the end of a plan year if they have either left the company or have been employed there for ten years. Other employees over the age of 65 are also eligible to receive benefits. The plan cannot force an employee to receive benefits prior to retirement age.
There are a host of other rules in the Internal Revenue Code, and those can be found on the IRS website. Private sector defined benefit plans must also comply with the Employee Retirement Income Security Act (ERISA).
Adding Gold to Your Defined Contribution Plan
If you are looking to add approved gold or silver bullion to your retirement portfolio as a hedge against economic uncertainty and inflation, you should look into whether or not your plan allows for a rollover into a self-directed gold IRA.
If your defined benefit plan does not allow for a rollover, don’t worry: you are still allowed to open establish other retirement accounts, including a self-directed IRA.