A defined benefit plan is an employer-sponsored retirement plan where benefits are determined by a formula based on factors such as salary, age, and length of employment. Employers manage investments and assume investment risks, and benefits can be provided as a lump sum or monthly payments. There are three main types of defined benefit plans: flat, unit, and variable.
A defined benefit plan is a type of employer-sponsored retirement plan. In a defined benefit plan, benefits are determined by a formula that indicates the amount an employee will receive upon retirement. The amount of the benefit is generally based on a number of factors, including the employee’s average salary before retirement, retirement age, and length of employment. Benefit amounts can be a specific dollar amount or a percentage of compensation.
Many people consider a defined benefit plan to be a traditional type of pension plan type. Generally, the employer is responsible for making all contributions to the defined benefit plan. However, in some cases, employees also make contributions. Defined benefit plans are typically found in larger companies.
A defined benefit plan does not require employees to make investment decisions. The employer is responsible for making decisions and managing investments for the plan. In addition, the employer assumes all investment risks. The assets of a defined benefit plan are held collectively, rather than in individual employee accounts. The employer is responsible for funding the plan as needed, even during periods when the company is not making a profit.
The benefits of a defined benefit plan can be provided as a lump sum at retirement or as monthly payments that continue for as long as the retiree lives. In some cases, defined benefit plans provide benefits to the employee’s beneficiaries after the employee’s death. These details vary from company to company.
The three main types of defined benefit plans are flat, unit, and variable benefit plans. A fixed benefit plan requires the employer to pay all retired employees a fixed dollar amount, provided they have reached a minimum number of years of service. For example, a fixed benefit plan might require payment of 30 percent of the average compensation amount paid to the employee for the last five years of employment. Alternatively, this type of plan could require a specific monthly payment to each employee who worked for the company for ten years or more.
In a unit benefit plan, the benefit amount is determined by multiplying the compensation percentage or a specific dollar amount by the number of years of employment. For example, the benefit could be five percent of the average compensation paid to the employee or a monthly benefit of $50 for each year the employee worked for the company in question. Actual amounts and percentages vary.
A variable benefit plan requires an employer to base benefit amounts on unit allocation to plan contributions. In this type of defined benefit plan, the benefit amount is based on a calculation of units allocated to the employee at retirement. The value of the employee’s units is proportional to the value of all the units in the fund.
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