A defined benefit pension plan is a retirement agreement. This type of agreement involves an employer making a specific up-front commitment to pay an employee a certain amount upon retiring. The payout usually involves a set amount to be paid at regular intervals. In some instances, however, a person may be able to receive a lump sum.
The benefits that an employer agrees to pay with a defined benefit pension plan are supposed to start when a person retires. Those benefits are supposed to continue until the person dies. In the United States, such plans are very common for employees in the public sector, but they are often offered in the private sector as well.
In order for this type of arrangement to work effectively, an employer normally considers a number of personal factors about the employee who is to receive the benefits. Examples include life expectancy, fluctuations of interest rates, and a person's earning history. If these factors are not considered, there is a risk that some employers may not be able to fulfill their obligations. These factors are used a components of a formula that is so complex that it usually requires special software.
Employers must determine how they will fulfill their commitments if they have agreed to a defined benefits pension plan. Companies normally try to fund this type of plan through investments that are made while individuals are still employed. Some plans require that the employees make contributions and others give them the option without obligation. Whether or not an employee contributes, the success of those investments is the responsibility of the employer. If, for some reason, the return on those investments proves inadequate, an employer is not relieved of his obligation to pay.
There is no need for an employee to feel that he must remain with a company for the sake of earnings that he has accrued through his defined benefit pension plan. A person who is vested will always be entitled to the monies that he has already earned. If he decides to leave the company before retiring, the accrued amounts should be held in trust until he reaches retirement age.
One of the benefits of a defined benefit pension plan is that a person's spouse may be able to continue collecting after his death. This part of the agreement usually needs to be specified or the option needs to be chosen before distribution of the funds begin. Even when this is done, the surviving spouse will usually only receive a percentage of the retired employee received while living.
