What Is a Defined Benefit Plan?
A defined benefit plan, or DBP, is a retirement plan offered by employers that provide employees with a specific monthly payout once they retire. This payout is usually based on the employee’s salary and length of service with the company.
DBP is different from other retirement plans, such as a 401k, in that the employee’s contribution is not based on how much money is put into the account.
The Benefits of a Defined Benefit Plan
An obvious benefit to DBPs is that the payout promised when an employee retires remains stable regardless of market conditions. As long as the employer can afford to continue offering the plan, this amount will not change.
This stability is one reason why DBPs are becoming less common in America- while they offer a sense of security, they are also seen as being less innovative than other retirement options.
Another benefit of DBPs is that employees often receive matching contributions from their employers. For example, an employer might match 50% of the employee’s contributions up to a certain amount. This increases the amount of money that the employee has saved for retirement.
Moreover, the ability to budget for their retirement is available as they know exactly how much money they will be receiving.
The Drawbacks of a Defined Benefit Plan
The main drawback to DBPs is that they can be very expensive for employers. Since the employer is responsible for guaranteeing a certain payout to employees, they must set aside more money to fund the plan.
Another issue that can arise with DBPs is that employees are often locked into staying with the company until they reach the payout age. If an employee changes jobs, he or she will lose the benefits accrued in the previous job.
Aside from the above-mentioned drawbacks, employees may not receive as much as they would if they were to invest on their own. This plan can also be more expensive for employers
DBP wouldn’t also enable employees to take advantage of certain tax deductions.
Why Do Employers Offer a Defined Benefit Plan to Employees?
Many employers choose to offer DBPs because they provide benefits to both parties.
For example, if an employee leaves the company before reaching the payout age, the employer will not have to pay out all of the money they had invested toward that employee’s retirement.
Another reason is to attract and retain top talent. It also provides employees with a guaranteed monthly income in retirement which helps them prepare and plan for it.
Also, DBPs offer employers peace of mind because their employees are receiving guaranteed income during retirement.
How Employees Contribute to Their Own Retirement Account With the Help of a Defined Benefit Plan
First, employees must find a DBP that their employer offers.
Second, they must make sure to start contributing early in order to accumulate a large sum by the time they retire. For example, if an employee invests $100 per month for 30 years and earns a 6% return, they will have saved over $47,000.
Third, employees should try to max out their employer’s matching contribution in order to get the most bang for their buck.
Fourth, employees should invest in a diversified mix of assets that can provide growth and stability.
Finally, it is important for employees to keep tabs on their accounts and make changes when needed.
Defined Benefit Plan vs. Defined Contribution Plan
Defined Benefit Plans and Defined Contribution Plans are two types of retirement plans employees can choose from.
In a DBP, the employer is responsible for making predetermined contributions to an employee’s account. While in a DCP, the individual who has the plan is responsible for choosing how their money will be invested.
How to Choose Between Defined Contribution and Defined Benefit Plans
When making the decision between a DC and DBP, it is important to consider what is important to you.
If you are looking for more control over your investments, then a DCP might be best for you.
However, if you prefer the comfort and security of knowing that your employer will guarantee a certain payout once retired, then a DBP is right for you.
Additionally, DBPs tend to have limited investment options while DCPs offer more freedom in choosing investments.
DBPs are an attractive retirement option to both the employer and employee, offering security in knowing exactly how much money will be received upon retirement.
Moreover, DBPs help employers attract and retain talented employees while giving them peace of mind by guaranteeing their employees will receive income during retirement.
It is important to note that DBPs come with some drawbacks. Employees are often stuck in their job until they reach the payout age. Also, employees must make sure to start early and contribute consistently in order to save enough for retirement.
When choosing the right retirement plan for you, it is important to consider your preferences and what you value.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.