A defined benefit (DB) plan is a type of employer-sponsored pension plan that promises a predetermined, guaranteed retirement income to employees. The benefit is typically calculated using a formula based on the employee’s earnings, years of service, and age at retirement.
Unlike defined contribution (DC) plans, where the retirement income depends on investment performance, a defined benefit plan places the investment risk and funding responsibility on the employer or plan sponsor. The employee receives a stable, predictable pension, regardless of market conditions.
Key features of a defined benefit plan
| Feature | Description |
|---|---|
| Guaranteed payout | Provides a fixed monthly pension benefit in retirement, based on a set formula |
| Formula-based calculation | Commonly based on final or average earnings and years of service |
| Employer responsibility | Employer is responsible for funding the plan and managing investments |
| Pension predictability | Offers employees a reliable and stable source of retirement income |
| Actuarial valuation | Requires regular actuarial assessments to ensure sufficient funding |
| Not market dependent | Benefit is not directly affected by investment performance |
Common pension formula examples
Final average earnings formula
a set percentage of the average of the last few years’ salary, multiplied by years of credited service
Career average earnings formula
a set percentage of average salary over the entire career, multiplied by years of service
Advantages for employees
- Predictable, lifelong income in retirement
- Not affected by market volatility
- Encourages long-term employee retention
Considerations for employers
- Requires long-term financial commitment
- Subject to regulatory funding requirements and actuarial oversight
- May present funding challenges during periods of low investment returns or demographic shifts
Summary
While increasingly rare in the private sector, defined benefit plans remain common in public sector employment. The employer bears the investment and longevity risk, which makes the plan more costly and complex to manage compared to other retirement plan types.