Defined-Benefit Plan

Defined-Benefit Plan

Overview

A defined-benefit plan (commonly called a pension) is an employer-sponsored retirement plan that guarantees a specific benefit at retirement. The benefit is calculated using a formula that typically considers factors such as final salary and years of service. The employer manages the plan assets and is responsible for paying the promised benefits, regardless of investment performance.

How it works

• The plan specifies a benefit formula (for example, a set dollar amount per year of service or a percentage of final average salary).
• At retirement, the employee receives either a lifetime series of payments (annuity) or, in some plans, a lump-sum distribution.
• The employer funds and administers the plan and bears the investment and longevity risk.

Contributions and funding

• Employers typically contribute regular amounts to a tax-deferred trust or plan account to fund future benefits.
• Some plans allow limited employee contributions, but most are solely employer-funded.
• Because the employer guarantees benefits, it must make up any shortfall if plan investments underperform.

Payout options

Common payment choices include:
* Single-life annuity — fixed monthly payment for the retiree’s life (stops at death).
* Qualified joint-and-survivor annuity — continued payments to a surviving spouse (often reduced to provide survivor coverage).
* Lump-sum payment — one-time distribution of the plan’s actuarial value (not always offered).

Selecting a payout option affects the monthly benefit amount and survivor protection; it’s wise to review options with a financial advisor.

Example

If a plan promises $150 per month for each year of service, a retiree with 30 years of service would receive:
150 × 30 = $4,500 per month for life.

Differences from defined-contribution plans (e.g., 401(k))

• Benefit guarantee: Defined-benefit plans promise a specific retirement income; 401(k)s do not.
• Risk: Employers bear investment and longevity risk in defined-benefit plans; employees bear those risks in 401(k)s.
• Control and access: Employers control plan assets and distribution rules in defined-benefit plans; 401(k) participants generally choose investments and can take loans or withdrawals (subject to plan rules and taxes).
• Portability: 401(k) balances are portable when changing jobs; defined-benefit pensions typically pay based on service with the sponsoring employer.

Pros and cons

Pros:
* Predictable, guaranteed retirement income.
* Employer assumes investment and longevity risks.
Cons:
* Less personal control over investments and timing of distributions.
* Potentially limited portability when changing jobs.
* Benefit amounts are formula-bound and may be lower than what a well-managed 401(k) could produce for some employees.

Planning tips

• Understand the benefit formula and how salary and years of service affect your payout.
• Compare pension payout options and consider survivor coverage if you have dependents.
• If you have both a pension and defined-contribution accounts, coordinate withdrawals and Social Security timing for overall retirement income planning.
• Consult a financial advisor to evaluate whether to accept a lump sum (if offered) or take an annuity.

Bottom line

A defined-benefit plan provides a predictable, employer-backed income stream in retirement. Knowing how the plan calculates benefits, the available payout options, and how it interacts with other retirement resources lets you make better choices about work tenure, distribution elections, and overall retirement strategy.