Legal Definitions - defined pension plan

A defined pension plan is a type of retirement plan where an employer promises a specific, predetermined benefit to an employee upon retirement. The amount of this benefit is typically calculated using a formula that considers factors such as the employee's salary, years of service, and age. Under this type of plan, the employer bears the investment risk and is responsible for ensuring there are sufficient funds to pay the promised benefits, regardless of how the plan's investments perform. Employees know in advance how their retirement income will be calculated, providing a predictable stream of income in their later years.

• Imagine Sarah, who has worked for a large manufacturing company for 30 years. Her company offers a defined pension plan that promises her a monthly retirement benefit equal to 2% of her average final five years' salary for every year she worked. When Sarah retires, she knows exactly how her monthly pension will be calculated based on this formula, regardless of whether the company's pension fund investments performed exceptionally well or poorly over the years. The company is legally obligated to pay her that specific amount.

  This illustrates a defined pension plan because the employer (the manufacturing company) has committed to a specific, formula-driven benefit amount (2% of average final salary per year of service) that Sarah will receive in retirement. The company, not Sarah, assumes the financial risk and responsibility for funding this promised benefit.

• Consider Mark, a public school teacher who is nearing retirement after 25 years of service. His state's teacher retirement system operates as a defined pension plan. The plan's rules state that upon retirement, Mark will receive an annual pension payment equivalent to 60% of his highest three years' average salary. Mark can confidently plan his retirement finances knowing this specific percentage of his past earnings will be paid to him annually by the state, irrespective of market fluctuations or the performance of the pension fund's investments. The state government is responsible for ensuring these payments are made.

  This example demonstrates a defined pension plan because the state government, as the employer, guarantees a specific retirement benefit (60% of highest three years' average salary) to Mark. The formula for calculating this benefit is clearly defined, and the employer bears the responsibility for funding and paying this guaranteed amount.

• A unionized construction worker, David, has been part of a multi-employer pension plan for 20 years, negotiated through his trade union. This plan is a defined benefit plan where, for every year of service, David accrues a right to a specific monthly payment in retirement. For instance, the plan might promise $100 per month for each year of service. So, after 20 years, David is guaranteed $2,000 per month in retirement. The union and participating employers collectively manage the fund and are responsible for ensuring these promised payments are made to all eligible retirees, regardless of the fund's investment returns.

  This illustrates a defined pension plan because David's retirement benefit is a fixed, predetermined amount ($100 per month per year of service) that is guaranteed by the plan's sponsors (the union and employers). The plan's design focuses on the specific benefit promised to the employee, with the employers collectively bearing the financial risk and responsibility for delivering that benefit.