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Defined-Benefit Plan

Also called: Pension plan

What is a defined-benefit plan?

A defined-benefit plan is an employer-sponsored retirement plan in which the benefits are determined by a company-specific formula.

  • Defined-benefit plans are employer-sponsored retirement plans. The benefits are defined by a formula to determine how much the employer should pay employees in their retirement years.
  • Defined-benefit plans can vary by how the payout is received and even by how the amount owed is calculated.
  • Employers are responsible for raising funds for their employees’ retirement. However, employees may contribute in some cases.

One notable aspect of a defined-benefit plan is that they are typically entirely funded and managed by the employer. Although employees can contribute to their defined-benefit plans, it depends on the stipulations set by their employer.

Much of how the plan works is designed by the employer. The benefits received for retirement by employees are defined by an employer's formula. This calculated amount can then be paid as a lump sum or regular payments to the beneficiary at retirement. Employers often fund the plan costs and are responsible for growing their contributions through risk-balanced investments. If their invested amount doesn’t grow to match the required amount detailed by their defined-benefit plan formula, the employer is responsible for covering any difference.

For example, an employee has worked at a company for 30 years and chooses to receive their retirement benefits from a defined-benefit plan in regular monthly payments. To calculate the total yearly amount owed to their retiree, the company applies a pre-determined formula; they will multiply the number of months the employee has worked for them by a dollar amount of $200. In this scenario, the retiree can expect to get a yearly sum of $72,000 from the defined-benefit plan (30 years x 12 months = 360 months worked in total; 360 x 200 = 72,000). If they have elected to get this amount through regular monthly payments, the retiree would receive $6,000 a month.