A defined benefit plan is commonly called a pension plan. This plan offers guaranteed retirement benefits to the employees. Generally, this type of pension scheme is funded by employers for its employees with retirement pay-outs as per a set formula. This formula for calculating the pension considers the employee's age, salary, and his/her tenure with the organization.
Qualified benefit or pension plans are known as defined benefit plans because both employees and employers know the formula to calculate retirement benefits ahead of time. The employers and employees use this formula to define and set the pay-outs of the pension scheme. Defined benefit plans are somehow different than retirement schemes like retirement savings accounts wherein the amount of pay-out depends on the investment returns. Key points about these pension schemes to consider are:
As employers are responsible for making the decisions of investment and managing it, thus it thinks about all the risks involved in planning and investment.
A defined benefit plan ensures certain benefits when a policyholder retires. How much you get depends on many factors including salary, age, and period of service with the organization.
Every year through pension statics benefits of the future that have to be paid from this plan are calculated, and ultimately it determines the amount that needs to be contributed to the policy to fund the projected pension amount. Generally, employers are the only contributors to this plan. However, defined benefit plans may require the contribution of the employees to the plan.
Before availing any right to get retirement benefits under a defined benefit plan, one may have to work for a certain number of years. This period is generally referred to as the vesting period. However, if one leaves a job before completing the vesting period as per the defined benefit plan offered by his/her employer, he/she may not get full retirement benefits from that plan.
Pension benefits under a defined benefit plan are calculated as per the formula. This formula can provide a set amount for each year one works for an employer or this formula can provide for a certain percentage of earnings. Many pension schemes calculate the retirement benefits by averaging the earnings of an employee in the last few years of his/her employment. By taking the average of specific percentage and then multiplying it with the number of service years of an employee provides the result.
Most of the defined benefit plans allow its policyholder to choose how does he/she wants the benefits to be paid. The payment options that are commonly offered are as follows:
Selecting the right payment option is necessary as it may affect the amount of benefit that one ultimately gets. So, one should consider all the available options carefully and should compare the amount of benefit paid under every option.
It is never early to plan for retirement. Income through pension, public provident fund, investments, and personal savings can help one to achieve his/her dreams of living well after retirement. One can start this by finding out how much he/she will get from his/her defined benefit plan at the time of retirement. If an employer is providing this facility, it sends the receipt for the same every year, however, one should read the fine prints of that. Finally, one should remember that any defined benefit plan does not provide the cost-of-living adjustments, therefore, the benefits that look lucrative now can be worth lesser in the future because of inflation.