Legal Definitions - defined benefit plan

A defined benefit plan is a type of employer-sponsored retirement program that promises employees a specific, predetermined payment amount upon retirement. Unlike other plans where retirement income might fluctuate based on investment performance or individual contributions, a defined benefit plan guarantees a fixed income stream, often paid out monthly, for the duration of the employee's retirement.

The employer bears the investment risk and is responsible for ensuring there are sufficient funds to pay out these promised benefits. The amount an employee receives is typically calculated using a formula that considers factors such as their years of service, salary history, and age at retirement. These plans are often subject to strict government regulations to protect employees' benefits.

Here are a few examples to illustrate how a defined benefit plan works:

• Example 1: Corporate Pension for a Long-Term Employee

  Imagine Maria, who worked for "Tech Innovations Inc." for 35 years as a software engineer. Her retirement plan is a defined benefit plan. Upon her retirement, the company calculates her monthly pension payment based on a formula: 1.5% of her average final five years' salary multiplied by her 35 years of service. Every month, for the rest of her life, Maria receives this exact, predetermined amount from Tech Innovations Inc., regardless of how the company's investments performed that year. The company is obligated to pay her this fixed benefit.

• Example 2: Public Sector Retirement for a Teacher

  Consider David, a retired high school history teacher who taught for 28 years in the "Cityville Public School District." His retirement is managed through a state-sponsored defined benefit plan for public employees. His pension is calculated using a formula based on his years of service and his highest three years of earnings. Each month, David receives a consistent pension check from the state's retirement system. He doesn't need to worry about stock market fluctuations affecting his income because his benefit amount is fixed and guaranteed by the plan, not dependent on the performance of an individual investment account.

• Example 3: Union-Sponsored Multi-Employer Plan

  Sarah is a retired electrician who worked for various contractors over 40 years, all of whom contributed to a union-sponsored multi-employer defined benefit plan. Her retirement benefit is determined by the total number of hours she worked throughout her career for contributing employers, multiplied by a set rate established by the plan. When she retired, the plan administrators calculated her monthly payout. Now, every month, Sarah receives a fixed sum from the union's pension fund. This amount is guaranteed, providing her with a predictable income stream, irrespective of the individual performance of the employers she worked for or the fund's investment returns in any given month.