Understanding of a ‘Defined-Benefit Plan’
Many employers find that in addition to sponsoring a defined contribution plan, such as a 401(k) Retirement Plan, Profit Sharing plan, a Defined Benefit plan allows them and other key employees to maximize qualified plan benefits. A Defined Benefit plan uses a formula that considers factors, such as length of employment and salary history, to determine employee benefits. The Employee Retirement Income Security Act of 1974 (ERISA), specifies the maximum benefit as well as the allowable retirement ages. A defined-benefit plan guarantees a specific benefit or payout upon retirement (see Total Approx. Accumulation). This benefit is accomplished through annual pre-tax contributions into moderate, tax-deferred, investment options that are selected and monitored by the plan sponsor and their financial professional.
Funding of ‘Defined-Benefit Plan‘ Explained
These plans are also known as pension plans or qualified benefit plans. The plan is termed ‘defined’ because the formula for calculating the employer’s contribution is known ahead of time. The employer typically funds the plan in a tax- deferred account by contributing a regular amount to the plan, usually a percentage of the employee’s compensation(see Annual Contribution).
The Defined Benefit plan is different from discretionary plans, in that the return of the funds invested in the Plan Trust have a direct impact on the funding targets necessary for benefit distributions; the targeted return in a defined benefit plan should usually fall between 4% to 6% annually. Therefore, if the returns from the investments set aside to fund the employee’s retirement result in a funding shortfall, employers must tap into the company’s earnings to make up the difference.
Since the employer is responsible for making investment decisions and managing investments for the plan, the employer assumes all the investment risk.
Defined Benefit contribution