WHAT IS 'Unit Benefit Formula'

Unit benefit formula is a method of calculating an employer's contribution to an employee's defined benefit plan based on years of service.

BREAKING DOWN 'Unit Benefit Formula'

Unit benefit formula means the company pays a percentage of the employee's salary for each year of service. One advantage of this retirement plan contribution system is that employees are compensated for working longer at a company. However, the unit benefit method requires the services of an actuary and, in turn, higher associated costs for the employer.

Unit benefit plan

A unit benefit plan is an employer-sponsored pension plan that provides retirement benefits based on a dollar amount or, more typically, a percentage of the employee's earnings for each year of service. A unit benefit plan is usually based on a percentage ranging from 1.25-2.5 percent. When the employee reaches retirement, their years of service are multiplied by the percentage multiplied by the career average salary to determine the employee's annual retirement benefit.

Defined benefit plan

A defined benefit plan is an employer-sponsored retirement plan where employee benefits are computed using a formula that considers several factors, such as length of employment and salary history. The company administers portfolio management and investment risk for the plan. There are also restrictions on when and by what method an employee can withdraw funds without penalties.

Defined benefit plans, which include pension plans or qualified benefit plans, are termed defined because employees and employers know the formula for calculating retirement benefits ahead of time. This fund is different from other pension funds, where the payout amounts depend on investment returns, and if poor returns result in a funding shortfall, employers must tap into the company’s earnings to make up the difference. Because the employer is responsible for making investment decisions and managing the plan's investments, the employer assumes all the investment risk. A tax-qualified benefit plan has the same characteristics as a pension plan, but it also gives the employer and beneficiaries additional tax incentives not available under non-qualified plans.

Qualified retirement plan

A qualified retirement plan meets the requirements of Internal Revenue Code Section 401a​​​​​​​ so is eligible to receive certain tax benefits. Such a retirement plan is established by an employer for the benefit of the company’s employees. Qualified retirement plans give employers a tax break for the contributions they make for their employees. Qualified plans that allow employees to defer a portion of their salaries into the plan also reduce employees’ present income-tax liability by reducing taxable income. Qualified retirement plans help employers attract and retain employees.

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