Defined benefit pension plans are retirement plans that are largely funded by employers and benefits are based on employee years of service, employee age and earnings. This type of pension plan has been declining in popularity, largely because the risk is mostly borne by the employer rather than the employee.
Contributions are largely made by the employer – for some employees this is definitely a pro, since the employer determines how much of a contribution is made and there are no caps on the total amount an employer can make to the plan annually. Having a defined benefit pension plan also does not limit the employee to having only one retirement plan, but instead they may have other retirement investments in addition to this plan.
The employer takes on risk – employers are responsible for paying pension benefits for the life of the employee; no matter how long the employee lives. If the employee lives longer than expected, the employer is still obligated to continue paying the pension benefit. Also, if the investment product fails to meet expectations and finance the employee retirement, the employer is still obligated to continuing paying the retirement benefit.
Contributions are often made to annuity-type investment products – since employer contributions are made annually, they are often invested in life annuity products or other similar investment products. Annuity products offer fixed rate returns and make planning for retirement easier for retirees.
Defined benefit pension accounts are insured – the Pension Benefit Guarantee Corporation is a federal entity that insures pension programs and ensures that people receive the minimum pension benefit amount if an employer is not able to make the benefit payment in full.
Defined benefit pension plans are primarily offered by larger employers – since the employer bears the burden of investment and payment of pension benefits, defined benefit pension plans tend to be offered by larger employers since they usually have the financial ability to bear these responsibilities, particularly if employees live longer in retirement than anticipated.
Maximum annual retirement benefit – one downside of defined benefit pension plans is that they have maximum annual retirement benefits. While this feature makes it easier for retirees and employers to plan on benefit distribution amounts, it also means that there is no opportunity for employees to add to the benefit distribution amount.
Employees are entitled to any monies invested on their behalf – if an employee leaves the company before retirement, any money invested on their behalf is held in trust for them until retirement age. This age is defined by the plan and may be earlier than 65, but retirees must begin claiming benefits before April 1 of the year they turn age 70 ½.
Defined benefit pension plans offer many benefits including limiting employee risk, fixed-rate benefit amounts and pension insurance. While defined benefit pension plans are declining in popularity, they still offer excellent benefits to employees who choose this route of retirement investment.
