Defined Benefit Plan

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Overview

A defined benefit plan is a retirement benefits pension plan that guarantees a monthly or annual payment to retired employees based on a certain formula using years of employment, employee age and employee earnings. In a defined-benefit plan, because the retirement benefits are guaranteed, they do not depend on how much the employee contributes or how well pension fund investments perform. In a defined benefit plan contributions from employees and employers is generally put into one big fund, which is invested together. When the pension fund is not able to cover all the costs of benefits for retired employees, the retirees must still get the check they were guaranteed, leaving costs that must be made up from an additional source and are the responsibility of the employer. This makes defined-benefit plans more risky for employers and more likely to lead to debt and unfunded pension liabilities. This type of retirement plan is in contrast to a defined contribution plan, in which retirement benefits are not guaranteed but depend on invested contributions from the employee and employer. Defined contribution plans, such as 401(k) plans, are not very risky for the employer since there are no guaranteed benefits for which the employer is responsible if investment performance falls short.

Many public pension plans use a defined benefit plans. For example, California Public Employees' Retirement System (CalPERS), the agency in the California executive branch that manages public pensions, provides defined benefit plans.