What are some key features of a defined benefit plan?


Quick Answer

Employers create different types of defined benefits plans based on employee salary history and duration of employment. These factors provide predetermined retirement benefits to employees or their beneficiaries either in the form of cash or a specific percentage paid out as a pension.

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Full Answer

Set employer contributions and benefits are calculated by an actuary for the employee to know what the final payout results in. The company holds the plans for all employees in a joint pool for investment purposes bearing all risks and portfolio management. Employees cannot access the benefits until retirement or penalties are levied if they choose not to wait.

In some plan variations, an employee can contribute jointly with the employer. This is usually based on a percentage of the employee's annual earnings. There is no way to project in advance what the final payout at retirement will be as benefits depend on how much was contributed in the employee's name and how well the pension fund investments performed. For this plan, employees shoulder the risk of fluctuations in investment returns.

A few defined benefit plans allow for the gains to be adjusted each year in line with effects of inflation also known as the Cost of Living Adjustment.

A defined benefit plan is one of the safest retirement plans for an employee as it legally binds and compels the employer to ensure there is enough money in the plan to payout for guaranteed benefits. Should the fail to honor the plan, the Pension Benefit Guarantee Corporation arm of the federal government because it insures defined benefits plans against such eventualities.

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