What is a Defined Benefit Plan?
A defined benefit plan is a type of retirement plan where an employer guarantees a specified monthly benefit upon retirement, based on an employee's earnings history, tenure of service, and age. This plan is often funded by the employer, who invests the contributions on behalf of the employees.
Key Features
- Guaranteed Income: Employees receive fixed monthly payments after retirement, providing predictable income.
- Employer Funded: Typically, the employer bears the investment risk and is responsible for funding the plan.
- Calculation Basis: The benefit is often calculated using formulas that consider salary history and years of service.
- Vesting: Employees may need to work a certain number of years to earn the right to benefits.
Advantages
The primary advantage of a defined benefit plan is the security it offers to retirees, as the income is guaranteed regardless of market conditions. This stability is especially valuable for those relying primarily on pension income during retirement.
Considerations
While defined benefit plans provide a secure income stream, they can be less common today compared to defined contribution plans like 401(k)s. Understanding the details of your employer's plan is crucial for effective retirement planning.