Defined Benefit Pension Plan
A defined benefit pension plan is a type of pension plan in which an employer promises a specified monthly benefit on retirement that is predetermined by a formula based on the employee’s earnings history, tenure of service, and age, rather than depending on investment returns.
A traditional pension plan that defines a benefit for an employee upon that employee’s retirement is a defined benefit plan. It is ‘defined’ in the sense that the formula for computing the employer’s contribution is known in advance. A defined benefit plan is any pension plan that is not a defined contribution plan where a defined contribution plan is any plan with individual accounts.
The most common type of formula used is based on the employee’s terminal earnings. Under this formula, benefits are based on a percentage of average earnings during a specified number of years at the end of a worker’s career. In the private sector, defined benefit plans are typically funded exclusively by employer contributions. In the public sector, defined benefit plans often require employee contributions.