Defined-Benefit Plan

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  • Post last modified:December 10, 2023
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A Defined-Benefit Plan (DB Plan) is a type of employer-sponsored retirement plan in which the employer commits to providing specific retirement benefits to employees based on a predetermined formula. The benefits are usually calculated using factors such as the employee’s salary, years of service, and age at retirement. Unlike defined-contribution plans, such as 401(k) plans, where the contributions are known, but the future benefits are not guaranteed, DB plans promise a specific benefit amount upon retirement.

Key features of Defined-Benefit Plans include:

1. **Guaranteed Retirement Benefits:**
– In a DB plan, the employer guarantees a specific amount of retirement income to employees based on a predetermined formula. This formula often considers factors such as the employee’s salary and years of service.

2. **Employer Responsibility:**
– The employer bears the investment risk and is responsible for ensuring that there are sufficient funds to meet the future pension obligations. If the plan’s assets fall short, the employer may need to contribute additional funds to fulfill the promised benefits.

3. **Calculation of Benefits:**
– The benefit amount is usually calculated using a formula that takes into account factors such as the employee’s years of service and final average salary. The formula may vary from plan to plan.

4. **Vesting Period:**
– Employees typically need to work for a certain number of years to become vested in the plan, which means they are entitled to receive the promised benefits upon retirement. Once vested, employees have a non-forfeitable right to the accrued benefits.

5. **Retirement Age:**
– The plan may specify a normal retirement age, at which employees are eligible to receive their full benefits. Early retirement options or deferred retirement may also be available with adjusted benefit amounts.

6. **Funding:**
– Employers are required to contribute funds to the plan regularly to ensure there are sufficient assets to meet future pension obligations. The contributions are determined actuarially based on the plan’s liabilities and investment assumptions.

7. **Actuarial Assumptions:**
– DB plans use actuarial assumptions to estimate future obligations, such as the discount rate applied to future benefit payments and the expected rate of return on plan assets. These assumptions can impact the plan’s funded status.

8. **Pension Benefit Guaranty Corporation (PBGC):**
– In the United States, private-sector DB plans are subject to regulation by the Pension Benefit Guaranty Corporation (PBGC). The PBGC provides a safety net by guaranteeing a certain level of pension benefits if a plan becomes insolvent.

9. **Decline in Popularity:**
– Defined-Benefit Plans have become less common in the private sector, with many employers favoring defined-contribution plans like 401(k)s. However, they are still prevalent in the public sector and certain industries.

10. **Employee Security:**
– DB plans offer a level of retirement security to employees, as they provide a predetermined stream of income during retirement. This can be particularly attractive to employees seeking stable and guaranteed retirement benefits.

Defined-Benefit Plans have long been a traditional form of retirement provision, but their prevalence in the private sector has diminished over the years due to factors such as increased life expectancies, changes in accounting rules, and the desire for more predictable retirement costs by employers. Public sector entities, however, often continue to maintain DB plans.