A defined benefit pension plan is an arrangement where the employer pays their employee a specific benefit for life which starts at their retirement. The amount to be paid is normally declared in advance and is normally based on factors like earnings, years of service and age. Such arrangements are usually devoid of contribution limits.
The employer is tasked with making the decisions about the amount of money to contribute as well as the areas in which it will be invested. The contributions are based on a formula which calculates the level of investment required to meet the defined benefit. The contributions are determined by actuaries. Here, statistical analysis is used to calculate how much future risks would cost and takes into account the beneficiary’s life expectancy and age of retirement. Other factors include possible changes to interest rates, the possibility of turnover and annual retirement benefit amount.
The employee is entitled to the vested accrued benefit that’s currently available. If they leave the company before retirement, the benefits earned are frozen and held in a trust till they reach the age of retirement. The defined plan needs to allow its vested employee to receive benefits no later than the 60th day after the plan year elapses in which the latest of the following events occur: the employee leaves the company, or has been in the plan for over a decade.
The plan can’t compel one to receive their benefits before normal retirement age. This is unless one has less than five thousand dollars invested in the plan. However, one must start receiving their benefits no later than April the first following attainment of the age of 70½ or the last year of employment, whichever comes later.
A defined benefit plan distributes the benefits via life annuities. Here, the employee receives equal, periodic payments of benefits for the rest of their lives. If one is married and chooses the joint and survivor option, the spouse can continue receiving the distributions of at least 50% of the amount following the person’s demise. In some cases, one can receive their benefit in one lump sum when they retire.