User:Rebecca E. Harvey/Defined benefit pension plan: Difference between revisions
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A '''defined benefit pension plan''' is a type of retirement plan in which an employer allocates specific amounts of money for participating, vested employees in a tax deferred account.<ref>http://www.businessdictionary.com/definition/defined-benefit-plan.html</ref> The plan is "defined" because the formula for calculating the amount contributed by an employer is known in advance. Differing from a [[defined contribution plan]], the benefits a retiree receives from a defined benefit plan (commonly referred to as a ''DB plan'') are not dependent on the success or failure of the [[portfolio]] in which the employer's contributions are invested.<ref>http://financial-dictionary.thefreedictionary.com/Defined-Benefit+Plan</ref> This distinction places the entire liability of economic market fluctuations and the particular portfolio's performance on the employer (or the ''plan sponsor''). The benefit that a participating employee | A '''defined benefit pension plan''' is a type of retirement plan in which an employer allocates specific amounts of money for participating, vested employees in a tax deferred account.<ref>http://www.businessdictionary.com/definition/defined-benefit-plan.html</ref> The plan is "defined" because the formula for calculating the amount contributed by an employer is known in advance. Differing from a [[defined contribution plan]], the benefits a retiree receives from a defined benefit plan (commonly referred to as a ''DB plan'') are not dependent on the success or failure of the [[portfolio]] in which the employer's contributions are invested.<ref>http://financial-dictionary.thefreedictionary.com/Defined-Benefit+Plan</ref> This distinction places the entire liability of economic market fluctuations and the particular portfolio's performance on the employer (or the ''plan sponsor''). The benefit that a participating employee will receive is traditionally calculated based on length of employment and terminal wages.<ref name=Investopedia>http://www.investopedia.com/terms/d/definedbenefitpensionplan.asp</ref> In some instances, the management level of a participant will also factor into the calculation. Because of the plan's tax-deferred status, there are restrictions on how early benefits can be received.<ref name=Investopedia /> The academic study of retirement is in the field of [[financial economics]]. | ||
==Calculation of defined benefit pension plans== | ==Calculation of defined benefit pension plans== | ||
===Eligibility=== | ===Eligibility=== | ||
To be eligible to receive benefits from a DB retirement plan, an employee must first work for an employer who is offering the plan. This is becoming much less common since the introduction of defined contribution plans in the 1980s, due to the decreased risk put on the employer by these plans.<ref>http://money.cnn.com/retirement/guide/pensions_basics.moneymag/index6.htm</ref> Only about 10% of employees in the United States private sector have defined benefit plans, although 90% of state and local governments still offer the plans.<ref>http://money.cnn.com/retirement/guide/pensions_basics.moneymag/index7.htm</ref><ref>http://money.cnn.com/retirement/guide/pensions_basics.moneymag/index8.htm</ref> | |||
Once an employee is hired, they must first meet participation requirements in order to join the plan. This is often either one year of employment with the plan sponsor or 1000 hours of service (about half a year of full-time employment).<ref name=indiv>http://www.individual401k.com/defined_benefit_plans/faq.htm</ref> | |||
After joining, the employee (now a ''participant'') must become vested in the plan or else they will not receive benefits upon retirement. Employers are permitted by law to require a participant to work at least 5 years before becoming 100% vested.<ref name=whatyou>http://www.dol.gov/ebsa/publications/wyskapr.html</ref> However in a graduated vesting schedule, the employer may require 7 years for 100% vested, but they must permit lower percentages of vesting for lesser years of service (such as 60% vested after 4 years of service).<ref name-whatyou /> Once vested, a participant can terminate their employment at any time and still receive benefits at retirement. | |||
===Final Average Pay plans=== | ===Final Average Pay plans=== | ||
==Types of defined benefit plans== | ==Types of defined benefit plans== | ||
===Flat benefit plan=== | ===Flat benefit plan=== | ||
===Unit benefit plan=== | ===Unit benefit plan=== | ||
Revision as of 07:16, 29 October 2010
A defined benefit pension plan is a type of retirement plan in which an employer allocates specific amounts of money for participating, vested employees in a tax deferred account.[1] The plan is "defined" because the formula for calculating the amount contributed by an employer is known in advance. Differing from a defined contribution plan, the benefits a retiree receives from a defined benefit plan (commonly referred to as a DB plan) are not dependent on the success or failure of the portfolio in which the employer's contributions are invested.[2] This distinction places the entire liability of economic market fluctuations and the particular portfolio's performance on the employer (or the plan sponsor). The benefit that a participating employee will receive is traditionally calculated based on length of employment and terminal wages.[3] In some instances, the management level of a participant will also factor into the calculation. Because of the plan's tax-deferred status, there are restrictions on how early benefits can be received.[3] The academic study of retirement is in the field of financial economics.
Calculation of defined benefit pension plans
Eligibility
To be eligible to receive benefits from a DB retirement plan, an employee must first work for an employer who is offering the plan. This is becoming much less common since the introduction of defined contribution plans in the 1980s, due to the decreased risk put on the employer by these plans.[4] Only about 10% of employees in the United States private sector have defined benefit plans, although 90% of state and local governments still offer the plans.[5][6]
Once an employee is hired, they must first meet participation requirements in order to join the plan. This is often either one year of employment with the plan sponsor or 1000 hours of service (about half a year of full-time employment).[7]
After joining, the employee (now a participant) must become vested in the plan or else they will not receive benefits upon retirement. Employers are permitted by law to require a participant to work at least 5 years before becoming 100% vested.[8] However in a graduated vesting schedule, the employer may require 7 years for 100% vested, but they must permit lower percentages of vesting for lesser years of service (such as 60% vested after 4 years of service).Cite error: Invalid <ref> tag; invalid names, e.g. too many Once vested, a participant can terminate their employment at any time and still receive benefits at retirement.
Final Average Pay plans
Types of defined benefit plans
Flat benefit plan
Unit benefit plan
Variable benefit plan
Types of payouts available
Management of defined benefit plans
Federal retirement laws
Investment strategies
Benefits
The most significant distinction between defined benefit plans and other retirement options is often regarded as their greatest benefit. Participants in a DB plan have very little control over their benefit, which translates into very little responsibility required. In the United States, when employees are faced with making monthly investments, setting up employer-matching contributions, choosing which funds to invest in, and planning out how much money is needed to support a retiree from retirement to death (which are all true for defined contribution plans), they often choose to do nothing or do too little.[9] DB plans are administered by an outside company and are funded by the plan sponsor, taking nearly all of the responsibility out of the hands of the participant. In a basic DB plan, the only actions required by a participant are filing initial paperwork to enter the plan, keeping their employer updated of address changes even after they leave the company, and choosing a type of monthly payout upon retirement.
Criticisms
Although the performance of the pension's portfolio does not affect payments made to retirees, some critics of defined benefit plans argue that participants should have a higher degree of control over the investments.[10] The most common argument for this is that participants can't invest more in their plans if they want to. If a DB participant desires a higher post-retirement payout, he or she must take out a separate IRA or 401(k), if available.
Defined benefit plans also traditionally have no adjustments for inflation post-retirement.[10] If a retiree is receiving $400 per month for the rest of their life, this amount will not increase even if the price index doubles, reducing the real value of the $400.
Related pension plans
Cash Balance Plan
Money Purchase Plan
References
- ↑ http://www.businessdictionary.com/definition/defined-benefit-plan.html
- ↑ http://financial-dictionary.thefreedictionary.com/Defined-Benefit+Plan
- ↑ 3.0 3.1 http://www.investopedia.com/terms/d/definedbenefitpensionplan.asp
- ↑ http://money.cnn.com/retirement/guide/pensions_basics.moneymag/index6.htm
- ↑ http://money.cnn.com/retirement/guide/pensions_basics.moneymag/index7.htm
- ↑ http://money.cnn.com/retirement/guide/pensions_basics.moneymag/index8.htm
- ↑ http://www.individual401k.com/defined_benefit_plans/faq.htm
- ↑ http://www.dol.gov/ebsa/publications/wyskapr.html
- ↑ http://money.cnn.com/retirement/guide/pensions_basics.moneymag/index9.htm
- ↑ 10.0 10.1 http://money.cnn.com/retirement/guide/pensions_basics.moneymag/index10.htm