Defined benefit plans, commonly called pensions, promise specific retirement income based on formulas considering salary and service. The employer bears investment risk and funds the plan to meet promised benefits. Once common, these plans have largely been replaced by defined contribution plans in the private sector.
Benefit Calculation
Benefits typically calculate as a percentage of final average salary multiplied by years of service. For example, 1.5% per year of service times final five-year average salary. Someone with 30 years earning $100,000 would receive $45,000 annually. Formulas vary by plan.
Funding Requirements
Employers must fund defined benefit plans according to actuarial calculations. Underfunded plans require additional contributions. Investment returns affect funding status. Regulatory requirements ensure plans can meet future obligations. This complexity and risk led many employers to freeze or terminate plans.
Global Prevalence
While declining in the US private sector, defined benefit plans remain common in public sectors and in other countries. Many national pension systems are defined benefit. Understanding local retirement systems is essential when employing internationally.