Defined Benefit Plans

Editor's Note: Understand the basics of defined benefit plans.

Tracy MorleyOverview: A defined benefit (DB) plan is a pension plan that provides a specific, determinable benefit upon retirement or other termination of employment. While these plans guarantee employees a certain benefit upon retirement, how much an employee receives usually depends on factors such as age, salary and years of service. DB plans are typically funded by the employer, although some plans call for employee contributions as well.

Benefits under a DB plan are based on the formula specified in the plan document. In general, the amount of the benefit will accrue for each year of employment, either as a flat dollar amount for each year worked, or as a specified percentage of compensation. Benefit formulas are typically based on years of service, a combination of earnings and years of service or a percentage of contributions. Common examples of benefit formulas that can be used are: (i) unit benefit formula; (ii) final average pay formula; and (iii) career average pay formula.

The employer bears the risk for DB plans and is responsible for ensuring that sufficient funds will be available for retirement payments. DB plans are usually insured by the Pension Benefit Guaranty Corporation (PBGC). Employers pay a per participant insurance premium on an annual basis. If the plan in underfunded, the employer pays an additional variable rate premium.

Author: Tracy Morley, SPHR, Legal Editor

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HR guidance on understanding defined benefit plans.