Defined Benefit Plan

What is a defined-benefit plan?

A defined-benefit plan is a type of retirement plan in which an employer promises to pay employees a certain amount of money at retirement, based on factors such as the employee’s length of service and salary history. The employer assumes the investment risk and is responsible for ensuring that there are sufficient funds to pay the promised benefits to the employees. These plans are typically sponsored by larger organizations, such as government agencies, public utilities and large corporations, and the benefits are usually calculated based on a formula that takes into account factors such as the employee’s salary and years of service. The benefits provided are often based on a percentage of the employee’s final average salary, multiplied by the number of years of service. The employer funds the plan and bears the investment risk, with the goal of having enough money to meet the promised benefits.

What is a defined benefit plan and how does it differ from a defined contribution plan?

A defined benefit plan is a type of retirement plan in which an employer promises to pay employees a certain amount of money at retirement, based on factors such as the employee’s length of service and salary history. The employer is responsible for ensuring that there are sufficient funds to pay the promised benefits and bears the investment risk.

A defined contribution plan, on the other hand, is a type of retirement plan in which an employer makes regular contributions to an individual account for each employee, rather than promising a specific benefit at retirement. Common examples include 401(k) plans and 403(b) plans. In defined contribution plans, the employee bears the investment risk and the employee’s retirement benefit will depend on the contributions made and the performance of the invested funds. HBR’s compensation research notes that defined benefit plans remain a significant differentiator in public sector and unionized workforce recruitment, even as they have declined in the private sector.

In short, in defined benefit plan, the employer guarantees a specific benefit at retirement, while in defined contribution plan, the employee has the account balance based on the contributions and investment returns.

What are the different types of defined benefit plans?

There are several different types of defined benefit plans, some of which include:

1. Traditional pension plans: These are the most common type of defined benefit plan, and typically pay a fixed benefit to retirees based on a formula that takes into account factors such as the employee’s salary and years of service.
2. Cash balance plans: These are similar to traditional pension plans, but instead of calculating benefits based on a formula, the employer sets aside a specific dollar amount in an account for each employee.
3. Target benefit plans: These plans aim to provide a specific level of benefits to retirees, but with the ability to adjust contributions or benefits based on the funding level of the plan.
4. Multiemployer plans: These are defined benefit plans that are jointly trusteed by a group of employers in the same or related industries, such as those in the unionized sectors, with the goal of spreading the risk and benefit costs among a large number of employers.
5. Governmental plans: Defined benefit plans are also sponsored by governments, which are usually offered to the public sector employees.

It’s worth noting that different types of defined benefit plans may have different rules and regulations, and may also be subject to different tax laws. It’s important for employees to be familiar with the specifics of the plan they are enrolled in and consult with a financial advisor or benefits professional to understand how it fits into their overall financial strategy and retirement plan. SHRM’s total rewards guidance highlights that while defined benefit plans are declining in the private sector, organizations that maintain them report significantly stronger long-term retention among tenured employees.

Understanding retirement benefits is core to any competitive total rewards strategy. Organizations using pre-employment assessments ensure every hire is grounded in verified skills. A data-driven hiring plan reduces mis-hire risk, while strong talent acquisition practices focused on skills-based hiring help organizations attract and retain top talent.

Frequently asked questions