Defined-benefit (DB) plan — quick definition
– A defined-benefit plan (often called a pension) is an employer-sponsored retirement arrangement that promises a specified retirement payout to the worker. The payout is calculated by a preset formula that typically uses factors such as salary and years of service. The employer manages the plan’s assets and is legally responsible for delivering the promised benefits.
How it works — key points
– Benefit formula: The plan spells out how much the retiree will receive. Commonly the formula ties a fixed dollar or percentage amount to each year of service and to pay (for example, $150 per month for every year worked).
– Who controls the money: The employer holds and invests plan assets. If investments underperform, the employer still must pay the promised benefit.
– Access: Funds in a DB plan generally cannot be withdrawn or borrowed before retirement age; the money is not portable in the same way a defined-contribution account (like a 401(k)) is.
– Payment forms: Plans may pay a lifetime monthly benefit (an annuity), a lump-sum distribution, or provide survivor options that continue payments to a beneficiary after the participant’s death.
– Employee contributions: Many DB plans are funded entirely by the employer, but some plans allow or require employee contributions depending on plan rules.
Common contrasts with a 401(k) (defined-contribution plan)
– DB plan: Guarantees a retirement income amount determined by the plan’s formula. Employer manages investments and bears investment risk.
– 401(k): The retirement benefit equals the account balance at distribution time; the employee typically chooses investments and bears market risk. 401(k) balances are portable and usually permit loans/withdrawals under plan rules.
A short checklist — what to confirm about any defined-benefit plan
– What exact formula determines the benefit (dollars per year or percentage of salary)?
– Which salary is used (final pay, average of last years)?
– How are years of service counted?
– Is the plan funded by the employer only, or can employees contribute?
– What payout options exist (single-life annuity, joint-and-survivor annuity, lump sum)?
– Will benefits continue to a spouse or other beneficiaries after death?
– Are payments guaranteed regardless of investment returns?
– Is the benefit accessible before retirement (usually no)?
Worked numeric example
– Plan rule: $150 per month for each year of service.
– Employee A retires after 30 years.
– Monthly benefit = 150 × 30 = $4,500 per month.
– Annual benefit = 4,500 × 12 = $54,000 per year.
– Note: The plan may allow a lump-sum instead of monthly checks; the lump sum would be calculated under plan rules (not shown here).
Payout option examples (common types)
– Single-life annuity: Fixed monthly payment that stops at the retiree’s death.
– Qualified joint-and-survivor annuity: Reduced monthly payment while alive, with continued payments (often at a fixed percentage) to a surviving spouse or beneficiary.
– Lump-sum: One-time payment equal to the plan’s current valuation of the benefit.
Potential disadvantages (concise)
– Less flexibility and portability for the employee compared with a 401(k).
– Employer bears funding and investment risk, which can create plan changes if the employer faces financial stress (check your plan terms).
– The guaranteed amount may be lower than what a well-invested 401(k) could produce over time; conversely, it provides security if markets fall.
Practical next steps for participants
– Obtain the plan summary and the benefit formula in writing.
– Work out how an extra year of service or a raise would change the payout.
– Review payout options well before retiring and discuss them with a financial professional if you need help comparing lifetime income versus lump sum.
– Confirm beneficiary rules and whether survivor benefits are automatic or optional.
Reputable references
– Investopedia — Defined-Benefit Pension Plan: https://www.investopedia.com/terms/d/definedbenefitpensionplan.asp
– Internal Revenue Service — When Can a Retirement Plan Distribute Benefits?: https://www.irs.gov/retirement-plans/when-can-a-retirement-plan-distribute-benefits
– Internal Revenue Service — Annuities — A Brief Description: https://www.irs.gov/retirement-plans/annuities-a-brief-description
– U.S. Department of Labor — Pensions (overview): https://www.dol.gov/general/topic/retirement/pension
Educational disclaimer
This explainer is for educational purposes only and not personalized investment or legal advice. Consult a qualified financial advisor or plan administrator before making retirement decisions.