A Defined Benefit Plan is a type of retirement plan in which an employer promises to pay their employees a predetermined and specific benefit amount at retirement. The benefit is calculated using a formula that typically considers factors such as the employee's salary, years of service, and age. Unlike defined contribution plans, the employer bears the investment risk, ensuring that the promised benefits are funded adequately regardless of market fluctuations.
For instance, a defined benefit plan might promise an employee a monthly pension that is calculated as 1.5% of their average salary over the last five years multiplied by their total years of service. If an employee has worked for 30 years and their average salary for the last five years is $50,000, they would receive a monthly pension of $1,875.
These plans are less common in the private sector today but are still widely used in government and public service jobs. They provide employees with confidence regarding their retirement income, often backed by insurance schemes that protect these benefits.