Types of Retirement Plans - Defined benefit

A defined-benefit retirement plan is a pension plan under which a participant receives a fixed benefit in retirement based upon compensation, age and years of service with a particular employer.

Under a defined benefit plan, it is the benefit that is "defined" as opposed to the contribution. The benefit is guaranteed by the Pension Benefit Guaranty Corporation (PBGC), a federal government agency. There are several variations of the defined benefit plan:

  • Traditional
  • Cash balance
  • 412(i) plan

  • Traditional pension plan
    Elements of a defined-benefit plan:
    • Provides the highest tax-deferred retirement savings for older, highly compensated employees.
    • Complex to design.
    • A formula determines the level of benefit a participant will receive upon retirement.
    • Types of formulas:
      • Flat amount formula -Provides a stated dollar amount to each plan participant regardless of compensation level. May require a minimum number of years of service.
      • Flat percentage formula - Provides a benefit that is a percentage of the employee's average earnings, either over a career, over the final few years of a career or, possibly, or over the most highly compensated years.
      • Unit credit formula - A more complex formula that gives a credit for each year of service that is multiplied by a factor based upon compensation. For instance, a unit credit formula may provide a benefit that 1.2% for each year of service multiplied by the employee's average salary. Two variations of this formula:
        • Career average - Formula uses the employee's average earnings from entire career with the employer.
        • Final average - Formula uses an average of compensation over the last three or five years of a career with the employer. Usually provides for a higher benefit as most workers are in their peak earning years just before retiring.
  • Cash balance plan- A qualified defined benefit plan in which an employer contributes to hypothetical individual accounts for each participant. The contribution and a minimum rate of return are guaranteed for each participant's account.
    • Favors younger employers who have more time to accumulate savings.
    • Retirement benefits may not accumulate sufficiently for employees who are older when they enter the plan.
    • Employer guarantee removes investment risk for employees. Participants make no investment decisions.
    • Benefits are guaranteed by the PBGC.
    • No actual accounts for individuals; all funds are pooled.
  • 412(i) plan - A defined-benefit pension plan funded solely by guaranteed annuities or a combination of annuities and life insurance.
    • Suited to small business owners who find it difficult to invest in their company, while also trying to save for retirement.
    • Unique in that it provides fully guaranteed retirement benefits, it must be funded by an insurance company and it provides the largest tax-deduction possible due to the large premiums paid each year.
    • May not be ideal for all small business owners. This plan would tend to benefit small businesses that are established and quite profitable.
Qualified Plan Rules and Options


Related Articles
  1. Retirement

    Understanding Defined Benefit Pension Plans

    An employer-sponsored retirement plan where employee benefits are based on a formula using factors such as salary history and duration of employment.
  2. Retirement

    How Does a Pension Plan Work?

    A pension plan is a savings plan maintained by an employer on behalf of its employees for their retirement.
  3. Professionals

    Qualified Retirement Plans

    FINRA/NASAA Series 66: Section 4 Qualified Retirement Plans. This section discusses two types of qualified retirement plans, defined benefit and defined contribution plans.
  4. Professionals

    Qualified Retirement Plans

    NASAA Series 65: Section 14 Qualified Retirement Plans. In this section two types of qualified plans: defined benefit and defined contribution plans.
  5. Financial Advisors

    Are Cash Balance Pensions the Best for Small Biz?

    Are cash balance pensions the right solution for your small business clients? Here's why they may or may not work for your firm.
  6. Retirement

    Retirement Plan Options: Defined Benefits Plans

    Total compensation is not limited to salary. Find out what else you should consider.
  7. Professionals

    Retirement Planning for the Self-Employed

    How to select a qualified retirement plan if you are self-employed and have no employees.
  8. Retirement

    Job Hunting: Higher Pay Vs. Better Benefits

    Focusing on salary may be a mistake. Find out which benefits have the highest long-run payoff.
  9. Taxes

    401(k) And Qualified Plans: Types Of Plans

    By Denise ApplebyDefined-Benefit PlansUnder a defined-benefit plan, employees' retirement benefits are predetermined by their compensation, years of service and age. For example, the plan ...
  10. Financial Advisors

    New 401(k) Pension Rollover Rule: Pros and Cons

    Is the new rule allowing participants to roll their 401(k) balances into pensions a good idea?
RELATED TERMS
  1. Unit Benefit Plan

    An employer-sponsored pension plan that provides retirement benefits ...
  2. Target-Benefit Plan

    A benefit plan that is similar to a defined benefit plan since ...
  3. Corporate Pension Plan

    A formal arrangement between a company and its employees - or ...
  4. 412(i) Plan

    A defined-benefit pension plan designed for small business owners ...
  5. Pension Plan

    A type of retirement plan, usually tax exempt, wherein an employer ...
  6. Defined-Benefit Plan

    An employer-sponsored retirement plan where employee benefits ...
RELATED FAQS
  1. How does a defined benefit pension plan differ from a defined contribution plan?

    Learn the differences between defined benefit plans and defined contribution plans when reviewing employer-sponsored qualified ... Read Answer >>
  2. Who bears the investment risk in 401(k) plans?

    Who actually bears the investment risk in a pension plan depends on the type of pension plan that is employed. In a broad ... Read Answer >>
  3. What are qualified retirement plan types?

    Understand the different types of qualified retirement plans and what they mean in terms of employee and employer contribution ... Read Answer >>
  4. Is a 401(k) a qualified retirement plan?

    Examine the different types of qualified retirement plans, and discover if a 401(k) meets the definition of a qualified retirement ... Read Answer >>
  5. What's the difference between a 401(k) and a pension plan?

    Discern the differences between 401(k) plans, in which employees assume the market risk, and pension plans, in which the ... Read Answer >>
  6. How can an entrepreneur save for retirement?

    Learn about the retirement savings plan options for entrepreneurs and small business owners, including administration and ... Read Answer >>
Hot Definitions
  1. Cost Of Debt

    The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; ...
  2. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  3. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  4. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  5. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
  6. Generally Accepted Accounting Principles - GAAP

    The common set of accounting principles, standards and procedures that companies use to compile their financial statements. ...
Trading Center