Defined-Benefit Pension Plan

Defined-Benefit Pension Plan Retirement Benefits Pension Plans Employee Benefits Investment Income Employer Contributions
A defined-benefit pension plan promises to pay a specified amount to each person who retires after a set number of years of service. These plans pay no taxes on their investment income.
On this page

Defined-Benefit Pension Plan in Detail

A defined-benefit pension plan is a type of retirement plan wherein an employer promises to pay a specified pension benefit amount to employees upon retirement. The amount paid is typically determined by a formula that considers factors such as the number of years of service and the employee’s earning history. These plans are known for providing predictability and stability in retirement income.

Key Features

  • Predefined Formula: The retirement benefits are calculated using a predetermined formula, often based on salary and years of service.
  • Employer Responsibility: Employers bear the responsibility for funding the plan and ensuring that there are sufficient assets to meet future obligations.
  • Tax Advantages: Income earned within the plan is generally exempt from taxes until it is distributed to retirees.
  • Funding Contributions: Contributions can be made solely by the employer or by both the employer and employee, depending on the plan structure.

Examples of Defined-Benefit Pension Plans

  1. Government Pension Plans: Many government employees are enrolled in defined-benefit plans that offer substantial retirement benefits.
  2. Corporate Pension Plans: Large corporations often provide defined-benefit plans as part of their employee benefits packages, providing security for long-term employees.
  3. Union Plans: Unionized workers may receive benefits through collectively bargained pension plans.

Frequently Asked Questions about Defined-Benefit Pension Plans

Q: What is a defined-benefit pension plan? A: A defined-benefit pension plan is a retirement plan where the employer guarantees a specific payment amount to retired employees based on a formula considering salary and service years.

Q: How is the benefit amount calculated? A: The benefit is generally calculated using a formula that includes factors such as years of service, age at retirement, and average earnings.

Q: Who contributes to a defined-benefit pension plan? A: Contributions can be made solely by the employer or jointly by both employers and employees, depending on the plan specifics.

Q: Are defined-benefit pension plans taxable? A: The investment income within the plan is not taxed until it is paid out to retirees, at which point distributions are subject to income tax.

Q: What happens if the employer faces financial problems? A: If an employer faces financial difficulties and cannot fund the pension plan, the Pension Benefit Guaranty Corporation (PBGC) in the United States may step in to protect the pension benefits up to a certain limit.

  • Defined-Contribution Plan: A retirement plan where the employer, employee, or both make contributions, and the final benefit amount depends on investment performance.
  • Pension Benefit Guaranty Corporation (PBGC): A U.S. government agency that protects the retirement incomes of American workers in private-sector defined-benefit pension plans.
  • 401(k) Plan: A popular type of defined-contribution retirement plan where employees contribute pre-tax earnings, sometimes matched by their employer.
  • Actuarial Assumptions: Estimates made by an actuary regarding future plan obligations and participant behaviors, used to determine the funding requirements for a defined-benefit plan.

Online Resources

Suggested Books for Further Study

  1. “The Handbook of Employee Benefits: Health and Group Benefits” by Jerry S. Rosenbloom
  2. “Fundamentals of Pension Mathematics” by Michael M. Parmenter
  3. “Retirement Plans: 401(k)s, IRAs and Other Deferred Compensation Approaches” by Allen J. Ennis, James E. Hickey, Jr.
  4. “Pension Finance: Putting the Risks and Costs of Defined Benefit Plans Back Under Your Control” by M. Barton Waring

Fundamentals of Defined-Benefit Pension Plan: Insurance Basics Quiz

### What is the primary characteristic of a defined-benefit pension plan? - [x] Predefined retirement income based on a formula - [ ] Employee-directed investment choices - [ ] Varied benefits based on investment performance - [ ] Absence of employer contributions > **Explanation:** A defined-benefit pension plan promises a specific retirement income predetermined by a formula considering factors like salary and years of service. ### Who is usually responsible for ensuring that a defined-benefit pension plan is adequately funded? - [x] The employer - [ ] The employee - [ ] A third-party administrator - [ ] The federal government > **Explanation:** The employer is primarily responsible for ensuring that the defined-benefit pension plan has sufficient funds to meet its obligations. ### What tax advantage do defined-benefit pension plans generally offer? - [x] Investment income is not taxed until distributions are made to retirees. - [ ] Contributions by employees are tax-deductible. - [ ] Employers can exclude contributions from taxable income. - [ ] Tax-free distributions to retirees > **Explanation:** Investment income within defined-benefit pension plans is tax-deferred, meaning that it is not taxed until it is distributed to retirees. ### What might happen if an employer with a defined-benefit pension plan goes bankrupt? - [ ] All pension benefits are lost. - [x] The PBGC may step in to protect some benefits. - [ ] The plan automatically converts to a defined-contribution plan. - [ ] Employees receive immediate lump-sum payments. > **Explanation:** If an employer with a defined-benefit plan goes bankrupt, the Pension Benefit Guaranty Corporation (PBGC) may step in to protect pension benefits up to certain limits. ### How is the benefit amount typically determined in a defined-benefit pension plan? - [ ] Based on employee contributions - [ ] On investment performance - [x] Using a formula based on salary and years of service - [ ] On employee-selected investment options > **Explanation:** The benefit amount in a defined-benefit pension plan is typically determined using a formula that considers the employee's salary and years of service. ### Can the investment income of a defined-benefit pension plan be taxed before distribution? - [ ] Yes - [x] No - [ ] Only if contributions are high - [ ] Only in certain states > **Explanation:** The investment income of a defined-benefit pension plan is generally not taxed until it is distributed to the retirees. ### What is an actuarial assumption in the context of defined-benefit pension plans? - [ ] The assumption that benefits will increase annually - [ ] Assumptions about future salary increases alone - [x] Estimates regarding future obligations and participant behaviors - [ ] Employee retirement preferences > **Explanation:** Actuarial assumptions are estimates regarding future plan obligations and participant behaviors, used to determine funding requirements for a defined-benefit plan. ### In most defined-benefit pension plans, who bears the investment risk? - [ ] The employee - [ ] The financial institution - [x] The employer - [ ] The government > **Explanation:** In defined-benefit pension plans, the employer bears the investment risk as they are responsible for providing the specified benefits regardless of investment performance. ### Which organization might protect the benefits of defined-benefit plans if employers default? - [ ] Internal Revenue Service (IRS) - [ ] Securities and Exchange Commission (SEC) - [x] Pension Benefit Guaranty Corporation (PBGC) - [ ] Centers for Medicare and Medicaid Services (CMS) > **Explanation:** If employers default on their pension obligations, the Pension Benefit Guaranty Corporation (PBGC) may protect the specified benefits within certain limits. ### What significant factor differentiates a defined-benefit plan from a defined-contribution plan? - [ ] Employer contribution - [ ] Portability of funds - [x] Predictability of benefits - [ ] Employee investment options > **Explanation:** The key differentiation is that defined-benefit plans promise a predictable benefit amount based on a formula, while defined-contribution plans depend on the performance of invested contributions.

Thank you for exploring the intricate details of defined-benefit pension plans and challenging yourself with our quiz! Continue refining your knowledge for a secure financial future.

Wednesday, August 7, 2024
Defined-Benefit Pension Scheme
Deficit Spending
Non-Contributory Pension Scheme January 1, 1
Allocated Benefits January 1, 1
Employee Retirement Income Security Act (ERISA) January 1, 1
Normal Cost in a Defined-Benefit Pension Plan January 1, 1
Past Service Liability January 1, 1
Pension Freeze January 1, 1
Cash Balance Pension Plan January 1, 1
Cash Or Deferred Arrangement (CODA) January 1, 1
Contributory Pension January 1, 1
Contributory Pension Plan January 1, 1

Accounting Terms Lexicon

Discover comprehensive accounting definitions and practical insights. Empowering students and professionals with clear and concise explanations for a better understanding of financial terms.