Phrases Made Easy: “Defined Benefit” and “Defined Contribution”
Note: **this is the second (2) of a series of four (4) blog posts that require some knowledge of previous posts to be understood. We recommend that you read them in order. Here is the suggested order of reading:
- Healthcare Reform: The Major Players
- Phrases Made Easy: “Defined Benefit” and “Defined Contribution”
- The Great Transition: Healthcare Benefits & Defined Contribution
- Health Reimbursement Arrangements (HRAs): The Employee Benefits Home Run
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Defined benefit and defined contribution are long, “scary” phrases. We’ve got news for you though: at Policy Advantage Insurance Services, we work hard to explain all this jargon in simpler terms. And even better news: these two are really easy.
That’s right, they’re actually quite simple to understand. Once you “get” them… you’ve got them (there are only two of them, and they won’t change). Understanding their concept will be a valuable tool for you… especially in the post healthcare reform environment.
In the past, these two phrases were most commonly associated with retirement planning. Now (as a result of healthcare reform), you’ll also want to understand them when it comes to health benefits planning. Here we go.
Phrase #1 — “Defined Benefit” made easy:
- “Defined Benefit” Example in Retirement Planning: You’re a teacher, you retire, and the school district sends you a monthly retirement check! Simple. That’s a “defined benefit.”
- Simpler Terms: The benefit (cash/check), has been defined (the dollar amount paid to you each month)
- Examples of “Defined Benefits” in Retirement and Healthcare Planning: a) pension plans (our example), b) cash-balance pension plans, and c) any group health insurance plan (large or small).
Phrase #2 — “Defined Contribution” made easy:
- “Defined Contribution” Example in Retirement Planning: You work at a software company. That software company matches your contribution to your 401k each month. That is a “defined contribution.”
- Simpler Terms: The contribution (match to your 401k account), has been defined (usually as a percentage).
- Examples of “Defined Contributions” in Retirement and Healthcare Planning: a) 401k’s (our example), b) ESOPs, c) stock bonus plans, d) profit-sharing plans, e) target-benefit pension plans, f) money-purchase plans, and g) health reimbursement arrangements (or HRAs).
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As mentioned, health benefits planning will begin to transition from “defined benefit” plans (ie: group insurance plans) to “defined contribution” plans (ie: HRAs). The reason: healthcare reform has created planning conditions that are suitable for this transition. Retirement plans evolved in similar fashion from pensions (defined benefit) to 401k’s (defined contribution).
If you followed along last week (“Healthcare Reform: The Major Players”), you would have read that HRAs were one of the “major players” we described. This is why: health reimbursement arrangements (or HRAs) will be the “vehicle” that will facilitate this change to defined contribution healthcare plans. We’ll begin to explain in our next blog post… so come back and read up!
Important Editor’s Note 11/22/2013: Since these original blog posts, federal guidance regarding “Stand-Alone HRAs” (which are addressed in-depth throughout these articles) has undergone significant changes. In order to stay in full compliance, please be advised that there are now many additional considerations when adopting this type of benefits planning strategy. Consult with a proper broker or insurance professional before utilizing employer dollars to purchase individual health insurance policies.
That’s all for now. We hope this information was beneficial, as these can be important concepts for anyone. Thanks for stopping by, and feel free to follow along at our other outlets:
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