What is a Defined Benefit Plan?
A Defined Benefit Plan is a type of employer-sponsored retirement plan that promises employees a predetermined monthly benefit upon retirement. This benefit is calculated using a formula that typically factors in the employee’s salary history, years of service, and age. Unlike defined contribution plans, where the retirement benefit depends on investment returns, a Defined Benefit Plan guarantees a specific payout regardless of market performance.
Employers are responsible for funding the plan and managing the investments to ensure that sufficient funds are available to meet future obligations. For example, an employee might receive a pension equal to 1.5% of their average salary over the last five years of employment, multiplied by their total years of service. Thus, the longer the employee works and the higher their salary, the greater the retirement benefit.
Defined Benefit Plans offer a reliable and predictable source of retirement income, often in the form of a monthly pension. However, they have become less common as many employers have shifted to defined contribution plans like 401(k)s, which shift the investment risk to employees. Despite this shift, Defined Benefit Plans remain a valuable option for those seeking guaranteed retirement income.
