Savings and Retirement: What are defined-benefit retirement plans?
Defined-benefit plans provide pension income to retired employees on the basis of a formula that accounts for a worker’s years of service at a firm and earnings. Distributions are typically made for the remainder of the employee’s life, making the plan similar to an annuity. Contributions are generally made by the employer only, who is responsible for determining what level of contributions is necessary to provide the promised benefits to all current and future employees. Contributions to defined-benefits plans are tax-deferred, meaning that neither the employer nor the employee pays tax on the initial contributions or accumulated earnings.
- Compared with other types of retirement accounts, the risk in a defined-benefit plan is borne mostly by the employer. If employees live longer in retirement than anticipated, or if the investments financing the employees’ pensions fail to meet expectations, it is the employer’s responsibility to increase contributions so as to make good on the promised benefits.
- Defined-benefit plans are more likely to be offered by large employers, who are better suited to bear the risk involved.
- Defined-benefit plans have been decreasing in popularity over the past few decades. From 1991 to 2003 the share of full-time employees at medium-size and large establishments participating in defined-benefit plans fell from 59 percent to 33 percent. Defined-benefit plans, however, are still the most common type of plan for government employees.
- Defined-benefit plans are insured by the Pension Benefit Guarantee Corporation, a federal entity whose responsibility is to ensure that employees receive a minimum pension benefit in the event that their employer is unable to pay the promised benefits in full.