Definition
A Benefit-Based Pension Plan, often referred to as a Defined Benefit (DB) Plan, is a type of retirement plan in which an employer pledges to provide a specified monthly benefit upon the employee’s retirement. The retirement benefit is typically calculated through a formula considering factors such as the employee’s salary, years of service, and age. This formula-based approach ensures that the retirement benefits are known and predictable to the employees well in advance.
In the event that a covered plan terminates without sufficient assets to pay out the future benefits, corporate guarantees may come into play. This means that the company ensures the payment of insured benefits, typically through pension insurance arrangements or guarantees, insuring that retirees still receive their promised pensions.
Examples
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Traditional Defined Benefit Plan: An employee who worked for a company for 30 years may be promised a retirement benefit equal to 2% of their average salary in the last 5 years of employment multiplied by the number of service years.
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Pension Benefit Guarantee Corporation (PBGC) Backup: In the U.S., if a private-sector pension plan is terminated with insufficient funds, the PBGC can step in to cover the insured benefits, up to a legal limit.
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Corporate Pension Plans: Large corporations like IBM or General Motors historically offered DB plans where specific retirement income was guaranteed based on an employee’s salary and time with the company.
Frequently Asked Questions
What is a Benefit-Based Pension Plan?
A Benefit-Based Pension Plan, also known as a Defined Benefit Plan, is a retirement plan where employers provide a predetermined monthly benefit upon retirement. This benefit is often based on factors such as the employee’s salary history, years of service, and age.
How is the retirement benefit in a Benefit-Based Pension Plan calculated?
The retirement benefit is calculated based on a defined formula that typically takes into consideration factors such as the employee’s salary during the final years of service, the total number of years of employment, and sometimes age.
What happens if there are insufficient assets in the pension fund?
If a pension fund does not have sufficient assets to cover the promised benefits, corporate guarantees or insurance arrangements may be activated. In the United States, for example, the Pension Benefit Guarantee Corporation (PBGC) might insure and cover these benefits within certain limits.
Do employees contribute to a Benefit-Based Pension Plan?
While traditionally most DB plans were funded entirely by employers, some modern variations may require employee contributions as well. The specifics depend on the design of the pension plan.
Are Benefit-Based Pension Plans still commonly offered?
Due to the financial liabilities they pose, many employers have shifted towards Defined Contribution (DC) Plans such as 401(k)s. However, DB plans still exist in some sectors, especially within government and specific industry legal frameworks.
Related Terms
Defined Benefit (DB) Plan: Another term for Benefit-Based Pension Plan, emphasizing the predetermined nature of the retirement benefits.
Defined Contribution (DC) Plan: A retirement plan where the employer, employee, or both make contributions, and the retirement benefit depends on the investment performance of those contributions.
Pension Benefit Guarantee Corporation (PBGC): A U.S. government agency that insures and guarantees payment of certain benefits from private sector defined benefit pension plans.
Actuarial Assumptions: Financial assumptions used in the calculation of pension obligations, including life expectancy, salary growth rates, and discount rates.
Pension Fund: A pool of assets forming an independent legal entity managed to provide retirement benefits to employees.
Online References
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Investopedia - Defined Benefit Plan Investopedia Defined Benefit Plan
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Pension Benefit Guaranty Corporation (PBGC) Official Site PBGC
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IRS Guidelines on Retirement Plans IRS Retirement Plans
Suggested Books for Further Studies
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Pension Fund Excellence: Creating Value for Stockholders by Keith Ambachtsheer and D. Don Ezra.
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The Future of Public Employee Retirement Systems edited by Olivia S. Mitchell and Gary Anderson.
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Reinventing the Retirement Paradigm edited by Olivia S. Mitchell, Robert Clark, and Raimond Maurer.
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Fixing the Rollover: Current and Practical Solutions to the Retirement Income Challenge by Martin Neil Baily, Benjamin H. Harris, and Sita Nataraj Slavov.
Fundamentals of Benefit-Based Pension Plan: Corporate Finance Basics Quiz
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