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Defined Benefit Pension Plan

Key Features

  • Benefits determined by age/compensation
  • Higher maximum contribution
  • Good for owner/operators or employees with negotiated benefits
  • Favors older employees

A defined benefit pension plan is a pension plan which guarantees that a certain benefit will be available upon the retirement of a participant. This may occur in various ways. For example, retirement benefits of "50% of final average compensation", "$50 per month for each year of service" or "2% of average compensation for each year of participation" are different expressions of defined benefit plans. The important element here is that the benefit is determined by the age, compensation or employment of the employee and not by the amount of contributions made on his or her behalf.

The annual contributions must be determined by an actuary and will be redetermined each year to reflect the effect of current contributions, coverage and actuarial experience. There are minimum required contributions annually that need to be satisfied, so this type of plan is not as flexible as a 401(k) or profit sharing plan. Maximum contributions which may be made to a defined benefit pension plan are generally much larger than other types of plans.

Defined benefit pension plans are generally the most expensive type of retirement benefit available. They exist primarily in small companies or professional practices where the owner(s) are also the employees of the business, and in large companies which have negotiated benefits with employee organizations.

Defined benefit plans tend to favor older employees over younger employees, and are generally inappropriate where the group of employees intended to be benefited is below age 40.

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