What is a Defined-Benefit Plan?

by Investing School on October 3, 2012

There are a number of different employer-sponsored retirement plans. One of them is the Defined-Benefit plan. As the name implies, the benefits an employee receives upon retirement will be determined by a specific formula; they are defined. Factors taken into account in these calculations are things like the employee’s average salary prior to retirement, age and the duration of their employment.

The employee has no control over the types of investments in this plan; they are entirely controlled by the employer. On the positive side, with the final benefit defined, the employee is guaranteed to receive what was promised, even if the employer must dip into profits to make the payment. This type of benefit plan is more commonly found at larger firms.

Benefits that result from a defined-benefit plan may be provided in either a lump sum or monthly payments. If disbursed in a monthly fashion, payments continue for the life of the individual. There are even some circumstances in which the plan continues to pay benefits to the individual’s beneficiary. Specifics are available from each company.

There are three common types of defined benefit plans: flat, unit and variable. The flat plan requires an employer to pay all retired employees a fixed, determined dollar amount once they reach a certain duration of employment. The unit benefit plan calculates the benefit by multiplying a specified dollar or salary percentage amount by the years of employment. In a variable benefit plan the disbursement is calculated by the allocation of units to a particular employee.

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