A defined benefit plan is a type of retirement plan wherein the employer guarantees retired employees a specified monthly income for the rest of their lives. Also known as a pension plan, it offers a predetermined formula to calculate retirement benefits, typically based on factors such as an employee's age, length of service, and salary history. The plan establishes a clear structure, outlining how contributions will be made and how benefits will be paid out.
Unlike defined contribution plans, where the final benefit amount depends on the performance of the investments made by the employee, defined benefit plans relieve the employee of investment risk as the employer/administrator is responsible for managing and funding the plan. The employer is expected to make regular contributions and assume the investment risk associated with the plan to ensure that the necessary funds are available to pay out the promised benefits.
Upon retirement, the employee will receive a specified amount at regular intervals, often monthly, until their death or, in some cases, the death of their spouse or beneficiary. The amount provided is based on the predetermined plan formula, which may consider factors such as the employee's average salary during their final years of service and the number of years they have contributed to the plan.
Defined benefit plans provide employees with the advantage of a predictable income stream in retirement, offering financial security and stability. However, they require significant financial commitment and responsibility from employers, who must carefully manage and fund the plan to ensure its sustainability and ability to meet future benefit obligations.
