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What you should know about defined benefit (DB) plans

A pension, a defined benefit plan: Both terms refer to a unique program, less used now than in the past, that offers employees a retirement income stream after they work a certain number of years. It’s also a benefit that prompts a lot of questions. Here are answers to what you should know about DB plans.

Do I have to contribute to a defined benefit plan?

It depends, but usually no. Most defined benefit plans are employer sponsored, which means your workplace fully funds your enrollment. Some may require an employee contribution, but most do not, says Sharyl Priester, senior learning and development specialist at Principal®.

How often are benefits recalculated?

Each year during the defined benefit plan’s anniversary process, employers update the tenure and salary of each employee or former employee enrolled. During that anniversary period, you’ll also receive a defined benefit statement with estimated retirement-age benefits. “Typically, a pay increase and an additional year of service will result in an increased benefit,” Priester says.

Is the defined benefit payout statement exact?

No; the expected defined benefit payout is just an estimate. You’ll get an exact calculation once you have an exact retirement date.

One of my coworkers has a bigger projected benefit on his statement than I do. Why?

Defined benefit plans are individual, based on the plan’s exact benefit calculation, your years of service, and your salary. “Unless you and your coworker started on the exact same day and have held the exact same position and salary through the years, you can’t compare statements or benefits,” Priester says.

Will I have to pay taxes on my defined benefit payout?

Yes; the savings in a defined benefit plan are pre-tax, so you haven’t paid any income tax on them yet. You’ll have to pay income tax once you begin receiving payouts.

I want to do a survivor payout but my plan doesn’t offer it. Do I have options?

No. Whether other payout options are available depends on the plan. To learn more about payout options the plan may offer, read “What is a defined benefit plan?

My plan has both certain and life and survivorship options, so I need to choose a beneficiary. Can I name a child?

Generally no, but check the provisions of the plan. Survivor benefits are typically limited to someone who is closer to your age, such as a spouse, brother, or sister, Priester says. Or a plan may limit the survivorship benefit to a certain period, if younger beneficiaries are allowed.

Does the projected payout decrease if I choose something other than life annuity as an option?

Yes; the benefit will decrease to accommodate a projected benefit for your survivor. That’s because the defined benefit plan will extend what’s already been saved over a longer period to provide those benefits.

Why would I want to elect anything other than a life annuity payout?

The defined benefit payout option you choose depends on the expectations that you and your family have about retirement income. “What’s your end goal?” Priester says. “Are you single or do you have a spouse that might be relying on that income? Be proactive about understanding your choice.”

Can I complete defined benefit payout paperwork online?

If the service of the plan allows it, yes. But check if the plan requires forms such as a spousal consent or notary in writing so you have everything in place before requesting a payout.

Can I cash out my defined benefit plan?

If the plan allows it. But understand that if there is a total provided on a statement, it won’t match any cash-out value. For exact figures, contact your plan representative.

I’m going to retire early. Can I get defined benefit payouts early, too?

Most plans allow benefits to start at age 65, but some allow for early withdrawals starting as young as age 55 (although that will impact the payout amount). “If you elect early benefits, it most likely will equal a reduction in monthly benefit totals,” Priester says. Learn more about how defined benefit plans work with other retirement savings.

How long does it take to start receiving payouts?

It depends on when you file your request, as well as the processing lead time of your program. Check with your defined benefit plan for specifics.

I’ve begun receiving defined benefit payouts. Will those ever change?

No; the federal government requires that your employer set aside the pool of money that’s owed to you. Once you begin receiving payouts, those payouts remain the same until the end of your payout option, up to an amount guaranteed by the government, no matter what happens to the company.

 

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Sharyl Priester is a Principal Securities Registered Representative.

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.

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