HR GlossaryDefined Benefit Plan

Defined Benefits Plan

A defined benefit plan is a qualified, employer‑sponsored retirement plan that promises employees a pre‑established retirement benefit, as defined in the plan document. The benefit is typically determined using a formula that may consider factors such as an employee’s compensation, length of service, or a combination of both. 

What is a defined benefits plan? 

A defined benefits plan is a qualified employer-sponsored retirement plan that provides a fixed monthly amount at retirement. For example, the plan document may: 

  • Promise a set dollar amount (e.g., $200 per month upon the employee’s retirement)
  • Base the monthly benefit amount on factors like salary or length of service — for instance, 2% of the employee’s average salary for each of the last 5 years of service

Like other qualified retirement plans, defined benefit plans provide tax incentives to employers and participating employees. These plans are usually funded entirely by the employer. However, employees can be required to make contributions or contribute voluntarily. The funds in traditionally defined benefit plans are typically federally insured through the Pension Benefit Guaranty Corporation. 

What employers and employees like about these plans 

  • Benefits are defined by the plan formula and are not directly dependent on individual investment performance.
  • Employer contributions are actuarially determined and may be higher than contribution levels typically available under defined contribution plans.
  • Defined benefit plans are designed to provide a steady stream of income in retirement, which employees value for long‑term financial security.

Potential challenges of defined benefit plans 

  • Defined benefit plans are generally more complex and expensive to design and administer than defined contribution plans.
  • Employers must comply with minimum funding standards under the Internal Revenue Code, which may require significant and sometimes variable annual contributions.
  • Costs may include actuarial services, PBGC premiums (if applicable), and additional compliance and administrative expenses.
  • Failure to meet funding or participation requirements may result in excise taxes and required corrective contributions.
  • Defined benefit plans are more complex to administer than other types of retirement plans. This makes it more expensive to set up and maintain.
  • Failure to meet the IRS minimum participation and contribution requirements may lead to penalties

If you offer a defined benefit plan 

  • You can sponsor other types of retirement plans
  • Your company can be of any size
  • You must file a Form 5500 and Schedule SB annually
  • You must comply with benefit accrual, vesting, and funding rules
  • You must refrain from retroactively reducing accrued benefits, except as permitted by law
  • You must engage an enrolled actuary to perform required actuarial calculations and certifications

The importance of defined benefit plans to HR leaders and small businesses 

As with most things, defined benefit pension plans have pros and cons. HR leaders must examine the upsides and downsides when deciding whether to offer a defined benefit plan. Additionally, HR leaders must know the legal requirements under the Internal Revenue Code and the Employee Retirement Income Security Act. Most employers today offer a defined contribution plan, for example, a 401(k) — instead of a defined benefit plan. Small businesses, in particular, might not be equipped to handle the heavy responsibilities and costs of a defined benefit plan. That said, a defined benefit plan might be ideal for some businesses, such as those with very few employees.  

Summary 

A defined benefit plan is a qualified retirement plan that promises employees a pre‑established retirement benefit, often payable as a monthly annuity. These plans offer predictable benefits and potential tax advantages but require careful compliance with actuarial, funding, and reporting obligations. Employers should weigh the advantages and challenges carefully when deciding whether a defined benefit plan is appropriate for their organization.