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Defined Benefit Pension Plan

Key Features

  • Benefits determined by age/compensation
  • No maximum contribution
  • Good for owner/operators or employees with negotiated benefits
  • Favors older employees

A defined benefit pension plan is a pension plan which guarantees that a certain benefit will be available upon the retirement of a participant. This may occur in various ways. For example, retirement benefits of "50% of final average compensation", "$50 per month for each year of service" or "2% of average compensation for each year of participation" are different expressions of defined benefit plans. The important element here is that the benefit is determined by the age, compensation or employment of the employee and not by the amount of contributions made on his or her behalf.

There is no maximum contribution which may be made to a defined benefit pension plan, although there is a limit to the amount of benefits which may be provided (the lesser of 100% of final average compensation or $13,333 per month as adjusted for cost of living increases). The contributions must be determined by an actuary as the amount estimated to be required under the plan, and will be redetermined each year to reflect the effect of current contributions, coverage and actuarial experience.

Defined benefit pension plans are generally the most expensive type of retirement benefit available. They exist primarily in small companies or professional practices where the owner(s) are also the employees of the business, and in large companies which have negotiated benefits with employee organizations.

Defined benefit plans tend to favor older employees over younger employees, and are generally inappropriate where the group of employees intended to be benefited is below age 40.

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