What is a Defined Benefit Pension Plan?
Under a defined benefit pension plan, the contributions
are actuarially determined based on the anticipated benefit a participant
will receive at retirement. In other words, the first step in a
defined benefit plan is to determine (define) the ultimate retirement
benefit desired. This benefit, expressed in terms of a life annuity,
cannot exceed the lesser of $150,000 (2004) per year or 100% of
the average high three year compensation (indexed for inflation).
Under a defined benefit pension plan, a participant knows from inception
what their future retirement benefit will be. It is the company's
contribution that in unknown from year to year. The company bears
investment risk in that if the assets fail to earn the rate of return
that was used in the actuarial assumptions, a greater contribution
will be required the following year and possibly further years.
Or, conversely, if the investments outperform expectations, the
plan will have an actuarial gain which will reduce future contribution
requirements. Defined benefit plans favor older participants, since
large contributions may be made on their behalf, as they have less
time to fund for that benefit. The advantage of a defined benefit
plan is that the participant is not limited to 100% of annual compensation
or $40,000 like a defined contribution plan.