What is a Defined Benefit Plan?
A defined benefit plan is a type of retirement plan where an employer guarantees a specific payment amount to employees upon retirement, based on a formula that considers factors such as salary history and duration of employment.
Key Features
- **Predictable Retirement Income:** Employees can expect a stable income in retirement, which helps with financial planning.
- **Employer Funded:** The employer is responsible for funding the plan, which minimizes the financial burden on employees.
- **Longevity Risk Mitigation:** Defined benefit plans provide a lifetime income stream, reducing the risk of outliving savings.
How it Works
The payout from a defined benefit plan is typically calculated using a formula that factors in the employee’s final salary and years of service. For example, a common formula might be 1.5% of the final average salary multiplied by years of service. This means that employees with longer tenures and higher salaries receive larger benefits.
Advantages
- Provides reliable retirement income.
- Lowers investment risk for employees.
- May offer additional benefits like survivor benefits.
Considerations
While defined benefit plans offer numerous advantages, they are becoming less common as companies shift to defined contribution plans (like 401(k)s). Understanding the specifics of your plan is vital for effective retirement planning.