I really want to get back to this whole point of defined contribution versus a defined benefits plan, and what that can mean for you, because a couple of weeks ago, I mentioned in another video, that I was having a conversation with one of my students, and we were really talking about this whole concept of actively investing versus passively investing (https://youtu.be/LMc_y9VL0PY ), or maybe passively losing money, because you’re not really paying attention. We talked about, in that conversation, the whole concept of defined benefits, and defined contributions, and to his point, he was like, “I don’t really know the difference. I have never heard of the difference, and so, can you help me to understand?”

Here’s the link to my answer if you want to watch it and read the comments:

And so, if you found this video, you probably are in a very similar space, and I want to be able to help you understand the two different types of plans, because a lot of times we talk about retirement plans, but these are two very different types of plans that will impact you, and potentially your family in very different ways. After that conversation, I ended up finding myself sitting at a lunch table with my wife and her grandmother. Her grandmother is 101 years old, and when I started thinking about all of the different things that she seen in her life, and also, how she’s living her life today, it really helped me to crystallize the different between these two plans, because her grandmother, if you can think about this, 100 years ago, she’s seen some pretty amazing things in her life.

She’s seen everything from a civil war in her own country, where I live here in Spain. She’s lived through World War Two, she’s lived through the Vietnam War. I mean, these are some pretty monumental things that have happened over the last hundred years. She’s also seen some pretty positive things. In 1954, she heard or saw about Roger Banister breaking the four minute mile. She’s seen the civil rights movement in the United States, in the ’60s, lived through people in space and on the moon, and even most recently, things like Facebook being founded, and even the iPhone.

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The reason I’m tell you that is that a lot of things have happened. One of the things that also happened is during that time, she lost her husband. Although she lost her husband, even today, there are benefits that continue to come to her through a defined benefits plan, and because that happened for her, there was something that actually changed, and that started in the United States in 1974, with the start of the ERISA, which is the employee retirement income security act in the United States, which brought about this whole concept of defined contribution.

I want to explain the difference between the two, so that you really understand and you can ask the question at your employer, or if you’re starting your own company, realize what is the right type of plan for you. I guess, to also put a little bit of context around this, in 1974, at least in the US, the life expectancy was 72 years old, right? And retirement, at that time, was 65 years. So you have about seven years, more or less, from retirement to the end of your life, at least that’s the way people saw it.

And then also, if you look at where we are now, today, in 2018, the average life expectancy is around 79 years old, and average retirement age is only increased one year, so 66 years old. So, between seven years in 1974, and 13 year difference between retirement and life expectancy, we can see that there’s a pretty big gap. So, understanding defined contribution versus defined benefits, in terms of what will happen in payments in your retirement is something that’s really important to understand.

I want to talk you, specifically about the difference between defined benefits and defined contribution along five axises.

The first is, how do you actually make the contribution? Or more importantly, who makes the contribution? I want to talk to you also, about where does the investment take place. I want to talk to you about how do you get the money in retirement, or how do you determine how much money you’ll have in retirement. I want to talk to you about how it’s paid out, and lastly, I want to talk to you about if there are any additional benefits that you can apply for.

So, let’s start at the top. So, if you look at the different types of ways that you can contribute to the plan. Now, if we look at the defined benefits plan first, this is, typically, something where the employer is actually contributing on behalf of the employee. At the same time, there are some plans where the employee will pay a portion, and will be withdrawn from their paycheck, but in essence, typically it’s the employer who is saving on behalf of the employee.

If you look at your defined contribution plan, which is typically like a 401K, or a 403B, if you work for a private company, and if you work for a city, state, or local government, at least in the United States, it’s another plan like a 457. Now, they may not call them 401K, 403B or 457, but in your country, I’m sure there are plans that are very, very similar. So, when you listen to the defined contribution plan, just think about whatever the plan is in your country.

But, in this type of plan, it’s actually the employee who is paying out of each paycheck, a portion of their salary, and usually you can use a specific portion so you can have up to six percent or eight percent, and then you may have a match by your employer, possibly. But, the majority of the contribution comes from the employee.

Next, I want to talk to you about the second point, which is where the investment takes place. So, if you are working for a company in a defined benefits plan, the actual way that you invest is through a pooled … Everybody’s money is pooled together, and it’s actually handled by an asset manager, and typically, the asset manager is going to invest, on behalf of the entire organization, and they’re going to do that in a diversified portfolio of funds, typically. But, it’s handled by an asset manager.

If we look at the defined contribution plan, in terms of where it takes place, it’s really the employee. So you have the power to invest in which ever fund your specific custodian is probably offering to you, but most importantly you are the person who’s responsible for make the decisions on the investment.

So, let’s go onto the third point. I want to talk to you about, actually the way that the money is used in retirement. And so, if we look at the defined benefits plan first, once again, this is going to be determined by some preselected criteria. It may be something like how long you’ve been with the company, or how long you’ve been a specific role, will be directly correlated to the way that you get the money in your retirement. Whereas, if we look at the defined contribution plan, the way that you get your money in retirement, its based on the amount of money that you actually saved, and that was either you saving it directly, from your savings which was withdrawn from your account, as well as if you have the option to have your employer to have a specific match, their funds too.

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So, however much money is in that specific account, including your own contribution and your employer’s, if they contribute, is the amount of money that you will be distributed in your retirement. So, this is the part that’s really important, right? How is it paid out? And let’s look at the defined benefits plan first and foremost, and I can even take you back to what we talked about with my wife’s grandmother in a bit. But specifically, once you have a defined benefits plan, the defined benefits plan will pay you for the rest of your life, which means that whatever the amount of money that you had, based on the criteria that we talked about before, you will receive that same amount of money every single month, for the rest of your life.

So, that is, in terms of a defined benefits plan. It’s something that your employer pays for the rest of your life. As it relates to the defined contribution plan, remember we talked about you had an amount of money that was in that pool, and that pool of money was there based on your contribution, and your employer’s match, and that will be done until that bucket of money runs out. Once that bucket of money runs out, well, there’s no more money left. So, you’ll have to find other ways to supplement the income.

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And speaking of supplements, I did want to talk to about, one of the things at the very end, which are some additional benefits. First and foremost, I want to talk about the defined benefits plan, once again. Now, some of the benefits that you can receive are, as I mentioned before, for instance, pretty typically, your spouse is able to also have the benefits. So in the case of my wife’s grandmother, although her husband passed away, the benefits continued to stay with her until the end of her life.

So, one of the things of the benefits is for you and your spouse, and that’s supplemental, and that can go on for the rest of both of your lives. As it relates to the defined contribution plan, typically, there is no passing on the benefit. If you’re not here, then the benefit stops, or you can look for finding some other type of supplemental income outside of the defined contribution plan. So, hopefully that’s been really clear. Like I said, I wanted to do a video that was a bit more in detail, in terms of being able to help you understand the difference between the defined benefits, as well as the defined contribution plan.

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Hopefully understanding the story, also helped to crystallize it a bit, and also think about some of the things that I’ve told you before, just in terms of the life expectancy, the way that it has gone up from 72 to 79, and the retirement age has gone from 65 to 66. So, there’s a lot more life when you have to make it with the same money, especially if you’re on a defined contribution plan. So, there are also ways for you to think about. I want you to at least have this information. Most importantly, I’d really love to get your comments, in terms of what you think about this video, how helpful it’s been for you.

I’d really appreciate any likes that you can do, and most importantly your comments because I want to continue to bring you value added content, if you liked it, I’d love to hear about it. If you didn’t like it, I’d also love to hear about it because I want to continue to make things that are going to be valuable and useful for you. So, once again everyone, my name is Billy Keels with KeePon Cashflow.

That’s my two cents for the day, and as always, I’d like to say Hasta la Próxima!

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