What is a Defined Benefit Plan?

A defined-benefit plan is a retirement plan that business owners / companies provide, where employee benefits are calculated using a formula that considers, length of employment and salary history. The company that maintains the defined benefit plan administers portfolio management and investment risk for the plan. 

simple retirement budget

Advantages of Defined Benefit Plans

Defined-Benefit Plans guarantees a specific benefit or payout when an employee retires. The benefit may be a set amount or may be calculated according to a formula that factors in years of service, age and average salary.

The employer typically contributes and funds the plan in a tax-deferred account by providing a regular amount to the plan, usually a percentage of the employee’s pay. Depending on the plan employees may also make contributions to the defined benefit plan.

Pros and Cons of a Defined Benefit Plan

  • Employers / Business Owners can contribute and deduct from taxes more than other retirement plans
  • Defined Benefit Plans provides a predictable benefit to those enrolled in the plan
  • Employers can have a specified vesting period employees have to work to for eligibility from immediate to spread out over 7 years
  • Contributions provided by employersBenefits are not dependent on asset returns
  • Plan can be used to promote certain business strategies by offering subsidized early retirement benefits
  • Most costly type of plan
  • Most administratively complex plan
  • An excise tax applies if the minimum contribution requirement is not satisfied
  • An excise tax applies if excess contributions are made to the plan
diversification of risk