In defined benefit plans, the annual benefit at retirement is generally defined based on each participant’s compensation and level of service. In some instances, the benefit can be defined as a flat dollar amount for each participant varying between participants, within IRS limitations. The plan sponsor reaps the rewards (and bears the risk) of the investment return.
At retirement (or termination of employment), the participant is entitled to the benefit defined by the specific plan provisions, subject to the vesting schedule of the plan.
The majority of plans have a traditional benefit formula as mentioned above. Alternatively, there are various hybrids plans such as:
A defined benefit plan is the most efficient way to provide a guaranteed level of retirement benefit for employees because it promises a benefit at retirement that is not a function of investment results.
The plan can be designed to manage the work force by encouraging early or later retirement.
Employer cost can be reduced by favorable investment returns.
A defined benefit plan can provide for a much larger tax deduction and accumulation of retirement funds on a tax favored basis for the older business owner or key employee because the IRS limits benefits, not contributions, and the plan promises benefits at a specific age.
In a defined benefit plan, investment losses result in additional employer contributions because the promised benefit has not changed.
Only in a defined benefit plan can you ensure your opportunity to achieve your retirement goals.