An Introduction to Defined Benefit Pension Plans

A Defined Benefit Pension Plan provides for a benefit amount to be paid to a participant upon retirement based upon a mathematical formula. Typically this formula uses compensation and years of service, and contributions are then made to fund the benefit. This type of Plan differs from a Defined Contribution (for example, a Profit Sharing or 401(k)) Plan in that a Defined Contribution Plan provides retirement benefits based on a participant's account balance, that is contributions accumulated with investment gains and losses. Appendix A describes how benefits in a defined benefit plan are calculated, which differs from the method used for Defined Contribution Plans.

Defined Benefit Pension Plans have two advantages that Defined Contribution Plans don't, namely:

1. Higher contributions. Higher contributions may be obtained by using either a stand-alone Defined Benefit Pension Plan, or in combination with a Profit Sharing or 401(k) Plan.

   As we shall see, it may be possible to obtain contributions that exceed $100,000 per year in order to fund for the benefits to be paid to a participant. Contrast this $100,000 with a 401(k) and Profit Sharing Plan contribution, where the maximum contribution cannot exceed $42,000 (or 100% of compensation if less) per year for a participant.

2. Credit for prior years of service. A Defined Benefit Pension Plan is the only type of Plan for which you can count service, for benefit and funding purposes, prior to the effective date of the Plan. Such service may have to be limited to five years.

Pension Review Services custom-designs Defined Benefit Pension Plans in order to meet the objectives of our clients. Illustrations of Defined Benefit Pension Plan contributions are shown on the following pages. Plans can be set up to allow immediate entry for employees, or to require an employee to complete one or even two years of service before becoming a participant.

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