4 min read
What is a defined benefit plan?
Commonly referred to as a pension, a defined benefit plan offers eligible employees a set amount of income for retirement.
Do you have access to a defined benefit plan through your employer? You might: Although not as widespread as they once were, defined benefit (DB) plans, also called pensions, still offer millions of people retirement savings they can rely on once they’re done working.
What is a defined benefit plan and how does it differ from 401(k) savings and individual retirement accounts (IRAs)? Let’s take a look.
Defined benefit vs. defined contribution plans
Many people are familiar with defined contribution (DC) plans: With these, both you and your employer contribute funds to a retirement savings account. Most people refer to them as 401(k) plans; that name refers to a section of the Internal Revenue Code.
Defined benefit plans, however, are employer-sponsored, meaning your workplace creates and contributes to an account for you, the employee, without typically requiring your contribution, says Sharyl Priester, senior learning and development specialist with Principal®.
Who is eligible for a defined benefit plan?
If your employer offers a DB plan, they will also determine eligibility, Priester says. Most require a certain number of years, such as two or three, of employment to be fully vested and eligible for the plan. Some may offer the plan to both full- and part-time employees.
How is a defined benefit payout calculated?
Most calculations use years of service—how long you work at an employer—and annual salary, and every employer differs. In general, the greater your salary or longer your term of service, the greater your benefit.
What do you receive after retirement from a defined benefit plan?
Much like a 401(k) plan, you will receive a monetary benefit from the DB plan (see below for details) after you retire.
Is every defined benefit plan the same?
No. Employers may choose different service calculations or different payout options, for example.
What are the options for defined benefit payout?
Every plan is required to have a monthly payout option; beyond that, your employer can choose to offer additional payout options.
|Defined benefit payout option||Details|
|Life annuity, or straight life||You receive the same payout every month until you die, at which time payouts cease. Most DB plans pay a monthly benefit.|
|Certain & life, or continuing coverage (CC)||You choose a certain period, such as 10 years, to receive guaranteed payments. If you live past that period, you still receive the same payment. If you die before that period ends, your beneficiary receives the income payments or lump sum cash equivalent (if allowed) for the remainder of the period.|
|Survivorship||You receive a monthly income for the rest of your life. You choose a percentage of that income, such as 50%, which goes to your beneficiary for the rest of his or her life.|
|Social Security adjustment||If you retire before age 62, this plan provides a larger DB benefit, and thus a larger level income. When you reach Social Security retirement age, your DB payout is reduced by the amount of Social Security.|
Are defined benefit plan payouts taxed?
Yes. All contributions made by your employer are pre-tax, so your payouts will be taxed as part of your normal retirement income. To learn more, read “What you should know about defined benefit (DB) plans.”
Does Social Security affect defined benefit plan payouts?
It depends on the type of defined benefit plan you’re enrolled in. For more details, read “How does a defined benefit plan work with other retirement savings?”
How does a defined benefit plan work with your other retirement savings? Log in to your Principal account. First time logging in? Get started by creating an account. Want to supplement your employer retirement savings? We can help you set up your own retirement account.
1 BLS Employee Benefits Survey
The subject matter in this communication is educational only and provided with the understanding that Principal® is not rendering legal, accounting, investment or tax advice. You should consult with appropriate counsel, financial professionals, and other advisors on all matters pertaining to legal, tax, investment or accounting obligations and requirements.