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Defined benefit (DB) pension plan is a type of pension plan in which an employer/sponsor promises a specified pension payment, lump-sum, or combination thereof on retirement that depends on an employee's earnings history, tenure of service and age, rather than depending directly on individual investment returns. Traditionally, many governmental and public entities, as well as a large number of corporations, provide defined benefit plans, sometimes as a means of compensating workers in lieu of increased pay.[1]
A defined benefit plan is 'defined' in the sense that the benefit formula is defined and known in advance. Conversely, for a "defined contribution retirement saving plan," the formula for computing the employer's and employee's contributions is defined and known in advance, but the benefit to be paid out is not known in advance.[2]
In the United States, specifies a defined benefit plan to be any pension plan that is not a defined contribution plan, where a defined contribution plan is any plan with individual accounts. A traditional pension plan that defines a benefit for an employee upon that employee's retirement is a defined benefit plan.
The most common type of formula used is based on the employee's terminal earnings (final salary). Under this formula, benefits are based on a percentage of average earnings during a specified number of years at the end of a worker's career.
In the private sector, defined benefit plans are often funded exclusively by employer contributions. In the public sector, defined benefit plans usually require employee contributions.[3][4]
Over time, these plans may face deficits or surpluses between the money currently in the plans and the total amount of their pension obligations.[5] Contributions may be made by the employee, the employer, or both. In many defined benefit plans, the employer bears the investment risk and can benefit from surpluses.[6]
- ^ Lemke and Lins, ERISA for Money Managers, §1:1 (Thomson West, 2013).
- ^ "defined benefit plan". businessdictionary.com. Archived from the original on 2009-06-12. Retrieved 2009-05-08.
- ^ "BLS Information". Glossary. U.S. Bureau of Labor Statistics Division of Information Services. February 28, 2008. Retrieved 2009-05-05.
- ^ "Glossary". Bahrain Investment Center:Glossary of Terms. Citibank. Archived from the original on 2009-04-22. Retrieved 2009-05-08.
- ^ "Glossary of Terms". Quick Facts. Goodyear. Archived from the original on November 21, 2008. Retrieved 2009-05-08.
- ^ "defined benefit plan". definition. investorwords.com. Retrieved 2009-05-08.