Which of the following is a characteristic of a defined benefit pension plan?

Employer-sponsored retirement plans are divided into two major categories: defined-benefit plans and defined-contribution plans. As the names imply, a defined-benefit plan—also commonly known as a traditional pension plan—provides a specified payment amount in retirement. A defined-contribution plan allows employees to contribute and invest in funds and other securities over time to save for retirement.

These key differences determine which party—the employer or employee—bears the investment risks and affects the cost of administration for each plan. Both types of retirement accounts are also known as superannuations.

Key Takeaways

• Employers fund and guarantee a specific retirement benefit amount for each participant of a defined-benefit pension plan.
• Defined-contribution plans are also popular with employees because they maintain control over their money and how it's invested (across a plan's available investment options). They can feel more assured that, with consistent and long-term saving and investing, the money will be there for them when they need it.

  A defined-benefit plan is an employer-sponsored retirement plan where employee benefits are computed using a formula that considers several factors, such as length of employment and salary history. The company is responsible for managing the plan's investments and risk and will usually hire an outside investment manager to do this.

  Typically an employee cannot just withdraw funds as with a 401(k) plan. Rather, they become eligible to take their benefit as a lifetime annuity or in some cases as a lump sum at an age defined by the plan's rules.

  Understanding Defined-Benefit Plan

  Also known as pension plans or qualified-benefit plans, this type of plan is called "defined benefit" because employees and employers know the formula for calculating retirement benefits ahead of time, and they use it to define and set the benefit paid out. This fund is different from other retirement funds, like retirement savings accounts, where the payout amounts depend on investment returns.

  Poor investment returns or faulty assumptions and calculations can result in a funding shortfall, where employers are legally obligated to make up the difference with a cash contribution.

  Key Takeaways

  • A defined-benefit plan is an employer-based program that pays benefits based on factors such as length of employment and salary history.
  • Pensions are defined-benefit plans.
  • In contrast to defined-contribution plans, the employer, not the employee, is responsible for all of the planning and investment risk of a defined-benefit plan.
  • Benefits can be distributed as fixed-monthly payments like an annuity or in one lump-sum payment.
  • The surviving spouse is often entitled to the benefits if the employee passes away.

  Since the employer is responsible for making investment decisions and managing the plan's investments, the employer assumes all the investment and planning risks.

  Examples of Defined-Benefit Plan Payouts

  A defined-benefit plan guarantees a specific benefit or payout upon retirement. The employer may opt for a fixed benefit or one calculated according to a formula that factors in years of service, age, and average salary. The employer typically funds the plan by contributing a regular amount, usually a percentage of the employee's pay, into a tax-deferred account. However, depending on the plan, employees may also make contributions. The employer contribution is, in effect, deferred compensation.

  Upon retirement, the plan may pay monthly payments throughout the employee’s lifetime or as a lump-sum payment. For example, a plan for a retiree with 30 years of service at retirement may state the benefit as an exact dollar amount, such as $150 per month per year of the employee's service. This plan would pay the employee $4,500 per month in retirement. If the employee dies, some plans distribute any remaining benefits to the employee's beneficiaries.

  Annuity vs. Lump-Sum Payments

  Payment options commonly include a single-life annuity, which provides a fixed monthly benefit until death; a qualified joint and survivor annuity, which offers a fixed monthly benefit until death and allows the surviving spouse to continue receiving benefits thereafter; or a lump-sum payment, which pays the entire value of the plan in a single payment.

  Selecting the right payment option is important because it can affect the benefit amount the employee receives. It is best to discuss benefit options with a financial advisor.

  Working an additional year increases the employee's benefits, as it increases the years of service used in the benefit formula. This extra year may also increase the final salary the employer uses to calculate the benefit. In addition, there may be a stipulation that says working past the plan's normal retirement age automatically increases an employee's benefits.

  Which of the following is the characteristic of a defined benefit plan?

  A defined-benefit plan guarantees a specific benefit or payout upon retirement. The employer may opt for a fixed benefit or one calculated according to a formula that factors in years of service, age, and average salary.

  What is a characteristic of a defined contribution pension plan?

  A defined contribution plan is a written contract by which an employer only or an employer and workers are required to make monetary contributions in view of providing the workers with retirement income.

  What is the key characteristic of a defined benefit plan verses a defined contribution plan?

  The main difference is what each of the plans promise to employees. A defined benefit plan specifies how much monthly retirement income employees receive upon retirement. However, a defined contribution plan simply specifies what the employee and employer contributes to a designated employee's retirement account.

  What is an example of a defined benefit pension plan?

  A defined benefit plan promises a specified monthly benefit at retirement. The plan may state this promised benefit as an exact dollar amount, such as $100 per month at retirement.