What Is A Defined Benefit Plan?

A Defined Benefit plan is the type of qualified plan that promises to pay an annual benefit upon the retirement of the participant. The level of the benefit is identified or defined according to the terms of the plan document. The level of benefit usually takes service and amount of average compensation earned by the employee into consideration. The benefits for plan participants are guaranteed by the Pension Benefit Guaranty Corporation (PBGC). Therefore, in cases of the under-funding of assets, employer dissolution, or plan termination, the participants have the security of knowing their benefits are preserved. Funding for Defined Benefit plans comes from the employer. The investment risk is borne by the employer, so if there is a shortfall of required assets in the plan, the employer must increase the contribution. There is no investment risk for the participant. The contribution level of the plan is determined annually by an actuary. For an HR Generalist, managing these plans effectively is a vital part of human resources compliance.

Example: Case Security Company is looking for a way to attract and retain workers and reduce its annual tax liability. The Company has steady profits so it can commit to a fixed level of contribution. Case Security determines that a Defined Benefit plan would meet its needs. The plan is NOT designed to require mandatory contributions. The plan benefit formula is 50% of an employee's final year's compensation. Mark, a plan participant, earned $75,000 in his final year of employment. His annual benefit during retirement will be $37,500 per year. These calculations must be made in accordance with labor law and employment law standards.

Some plan designs require participants to contribute part of their salary as an after-tax contribution (known as a mandatory contribution). This may fall under specific Section 125 or cafeteria plan guidelines depending on how the contributions are structured. If an eligible employee refuses to contribute to the mandatory contribution portion of the plan, he or she is not eligible for any defined benefit accruals.