Also known as a traditional pension plan, this plan promises the participant a specified monthly benefit at retirement. Often, the benefit is based on factors such as the participant's salary, age and the number of years he or she worked for the employer. The plan may state this promised benefit as an exact dollar amount, such as $100 per month at retirement. Or, more commonly, it may calculate a benefit through a plan formula that considers factors such as salary and service.
Defined Benefit explained
These plans provide a fixed, pre-established benefit for employees at retirement. Employees often value the fixed benefit provided by this type of plan. On the employer side, business can generally contribute (and therefore deduct) more each year than in defined contribution plans. However, defined benefit plans are often more complex and, thus, more costly to establish and maintain than other types of plans.
If you establish a defined benefit plan you can have other retirement plans, be a business of any size, need to annually file a Form 5500 with a Schedule SB, have an enrolled actuary determine the funding levels and sign the Schedule SB and you can’t retroactively decrease benefits.
Since the employer is responsible for making investment decisions and managing the plan’s investments, the employer assumes all the investment and planning risks.
Upon retirement, the plan may pay monthly payments throughout the employee’s lifetime or as a lump-sum payment. For example, a plan for a retiree with 30 years of service at retirement may state the benefit as an exact dollar amount, such as $150 per month per year of the employee’s service. This plan would pay the employee $4,500 per month in retirement. If the employee dies, some plans distribute any remaining benefits to the employee’s beneficiaries.
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