What’s a Defined Benefit Plan?

Defined Benefit plans guarantee a certain amount of retirement income to an employee based on the employee’s current salary, years at the employer, and other factors.

A Defined Benefit Plan involves a promise made to you by your employer to pay you a certain monthly “benefit” for the rest of your life, or for a certain number of years after retirement. The amount of the payment is pre-calculated using a formula which typically involves your age, your salary, the number of years you’ve worked for your employer, along with other factors.

If you satisfy the terms which entitle you to certain benefits, the employer bears the burden of funding the accounts necessary to be able to pay the benefit guaranteed to you. Actuaries must help an employer solidify the calculations and contributions necessary to achieve the anticipated result. Oversight and auditing keeps the plans from being underfunded.

Due to a long period of low interest rates, many pension plans, including ones at the state government level, have become drastically underfunded, and class action lawsuits have taken place all over the country. Benefits are vested after a certain period of time, and there is sometimes an option to take a lump sum settlement instead of pension payments, but you may have to wait until a certain age to access the funds.

Pensions are insured to an extent by the Pension Benefit Guaranty Corporation (PBGC), a government entity. Contributions are not taxable to the employee, but all distributions are taxed as income. Defined benefit plans were historically the best way to deduct the largest amount of compensation to employees, and some plans still allow for deductions as high as $200,000 a year per employee, if the employee’s income is high enough.

What’s the Difference between a Defined Benefit Plan and a Defined Contribution Plan?
Can Something Happen to My Defined Benefit Plan?