A defined benefit plan provides a predetermined, level of benefit payments for the life of the participant or the life of the participant and spouse. The monthly retirement benefit is calculated using a formula specified in the plan. The employer contribution is required annually and is typically higher than a defined contribution plan, depending on the employer's demographics. The employer bears the investment risk. Older employees tend to be favored because they have a shorter time to fund for their retirement.
Types of Defined Benefit Plans:
A. Traditional Defined Benefit Plan: The employer makes an annual tax-deductible contribution to the plan. Tax deductions are subject to Internal Revenue Code limitations. This amount is actuarially determined each year and is usually a formula based on a combination of compensation and years of service. The plan is funded entirely by the employer and annual contributions are required.
B. Cash Balance Plan: A cash balance plan is a type of defined plan that has the characteristics of a defined contribution plan. Each year a participant's account is credited with a pay credit and an interest credit. The pay credit is dependent upon each participant's compensation. The Growth of the participant's accounts depends on the pay credits that the employer contributes. A cash balance offers more profitability than traditional pension plans since participants can take his/her vested account as a lump sum upon termination of employment.